The voices of Urban Institute's researchers and staff
November 1, 2016

Student loan forgiveness is no free lunch

November 1, 2016

After years of scrutiny, the US Department of Education levied sanctions on ITT Tech that forced the company into financial insolvency. Since ITT Tech may prove to be the bellwether of additional institutional closures, it is worth considering how abrupt school closures affect students, whose lives are never quite as simple as policy analysts contrive them to be.

While some see ITT Tech’s closure as the only way to rescue students from the brink of student loan disaster, displaced students may soon understand why Ronald Reagan once said that the nine most terrifying words in the English language are “I’m from the government, and I’m here to help.”

For the students who were currently enrolled at ITT Tech or who had withdrawn less than 90 days before the school’s closure, the Department of Education’s actions may appear to be a win. After all, at least those students are eligible to be considered for closed school loan forgiveness. But what those students might not understand is that by accepting loan forgiveness, they forfeit any credits earned in association with those loans.

In the monster of federal quid pro quos, when the department forgives you of your loan repayment obligations as the result of a school closure, they also take away your credits—like they never even happened. Keep in mind that under new regulations promulgated on Friday, students will automatically have their debt forgiven (and presumably their credits erased) if within three years of the school’s closure they have not reenrolled at least half-time at another institution.

Of course, the Internal Revenue Service (IRS) doesn’t quite see closed school loan forgiveness as a “never-happened” event, since this form of loan forgiveness is taxed as ordinary income. So the student who receives loan forgiveness—whether because he or she applied for it or received it by default in three years—will pay between 10 and 39.6 percent of the forgiven loan value, depending on their household income. The IRS has relieved Corinthian College students of this tax liability, but has not done so for students at other closed schools.

Students who keep their credits and transfer to a new school to complete a similar program pay a steep price as well because even if they were only one or two classes away from graduating at ITT Tech, they need to complete 25 percent of their total credits at the new institution, potentially adding months or years to their educational path. The 25 percent rule has not been waived. Only by completing an unrelated program at the new institution can a student transfer credits from the closed school and still qualify for at least partial loan forgiveness.

It appears that Congress has identified language in the Higher Education Act that will allow the secretary of education to reinstate whatever percentage of their 600 percent Pell grant eligibility (six years) students may have expended at the closed institution, but similar language has not yet been identified to allow GI Bill benefits to be restored.

These negative consequences are why institutions must act in the best interest of students and be held accountable when they don’t. But they also illustrate why educators and accreditors favor institutional improvement plans over punitive actions since fixing what is wrong with an institution to preserve what is right is almost always in the best interest of students.

Lawyers, scholars, and policy wonks will spend years determining whose actions were less legal: the Department of Education’s (for violating ITT Tech’s due process rights and applying sanctions that they knew would cause an abrupt closure) or ITT Tech’s. In the meantime, we need to figure out how to help displaced students prepare for the tax bills yet to come and make sure they understand that like all things in life, loan forgiveness is far from being free lunch. 

Photo by Jonathan Weiss/Shutterstock

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