Whether you are paying for college or university with a scholarship, grant, federal student loan, or private Installment loan, you may be wondering if you qualify for a loan interest deduction.
Here, you will learn about how taxable income works and how you may be able to receive tax credits when you pay interest on qualifying student loans.
Is Interest on Student Loan Payments Tax Deductible?
Wondering if student loan interest is deductible on your tax return? Yes, in many circumstances, borrowers may be able to receive a tax break for the interest paid on a qualified student loan. Generally, how student loan interest deduction works are borrowers may claim a maximum of $2,499 or the exact amount of interest they paid with their monthly student loan payments over the course of one year.
Students may be able to get a tax deduction on student loan interest if they meet all of the following requirements:
- The borrower’s filing status is anything other than married filing separately.
- Nobody else can claim the borrower as a dependent on their own tax return.
- The borrower is legally obligated to pay interest on their qualifying student loan.
- The borrower has actually paid interest on their qualifying student loan.
Furthermore, student loan interest deductions are reduced gradually and ultimately eliminated when the borrower’s modified adjusted gross income (MAGI) reaches the annual limit for that consumer’s filing status. What this means is that the more money a consumer makes yearly (depending on if they are filing jointly or individually), the less they are able to deduct when it comes to tax breaks on student loans.
According to the Internal Revenue Service (IRS), MAGI is identical to many people’s regular adjusted gross income (AGI).
What Qualifies as Interest for Student Loan Debt?
What exactly qualifies as interest when it comes to federal student loan payments? There are four main categories of interest that students can claim on their education loans: they are the loan origination fee, capitalized interest, interest on revolving lines of credit, and interest on refinanced or consolidated student loans.
- Loan Origination Fee – Origination fees are a type of underwriting charge most lenders require. In order for a loan origination fee to qualify as deductible interest, the fee must not be for any properties or services that are directly provided by the lender.
- Capitalized Interest – Capitalized interest is unpaid interest from a student loan that the lender adds to the outstanding principal balance. Student loan borrowers cannot claim capitalized interest for any student loans that they have not made a payment on in at least a year.
- Interest on Revolving Lines of Credit – If a student uses a credit card or other line of credit to pay exclusively for qualifying education-related expenses, they may be able to use any interest paid on that line as a student loan interest deduction.
- Interest on Refinanced or Consolidated Student Loans – This type of funding includes loans that were used solely to refinance existing student loans. It doesn’t matter how many loans were combined in the refinance/consolidation loan as long as the entirety of the funding was used to pay for qualifying higher education.
Expenses that would not be included in a student loan interest deduction on your next tax return would be:
- Paid interest on any loan where interest payments are not required.
- Origination fees that are used to pay for properties or services that the lender provides, such as commitment fees or processing fees.
- Interest on loans paid through certain loan repayment assistance programs, such as the National Health Service Corps Loan Repayment Program (the NHSC Loan Repayment Program).
Who Can Deduct Student Loan Interest on Taxes?
Borrowers who took out a student loan for themselves, their spouse, or a dependent may take advantage of student loan interest deductions on their taxes. Unfortunately, loans from a related person in your family or from a qualified employer plan are not eligible for interest deductions on student loan payments.
In order to receive deductions for student loan interest payments, borrowers must meet the following requirements:
- The loan must be for you, a spouse, or a person who is your dependent.
- The interest must be paid or incurred within a “reasonable period of time” before or after the loan was taken out.
- The loan taken out for an “eligible student” must be used to pay for education provided during an academic period.
In these qualifications, a “reasonable period of time” is defined as a specific academic period where funds were dispersed either 90 days before or after the start of that academic period. Traditionally, academic periods are identified as a semester (where the academic year is broken up into two sections), a trimester (where the academic year is broken up into three sections), a quarter (where the academic year is broken up into four sections), or another period of study (such as a summer session of schooling).
Furthermore, an “eligible student” for student loan tax deductions is a student who is enrolled in a degree program, certificate program, or another recognized educational credential at least half-time.
How To Write off Student Loan Interest on Taxes
Borrowers should receive Form 1098-E if they have made qualifying interest payments of $600 or more during the previous calendar year. Students can complete Form 1040, 1040-SR, or 1040-NR to receive eligible tax deductions from scholarships or fellowship grants. In order to receive any eligible tax breaks you may qualify for, you would simply complete the appropriate form and send it in along with your regular W-2 and other tax documents. If you do not receive any of the forms mentioned above, you may not qualify for a student loan interest deduction.
Types of Financial Assistance for Higher Education
There are a few different types of financial aid that students may receive to pay for their higher education. Eligible tax deductions may vary depending on the type of financial assistance students receive.
- Scholarships: A scholarship is a funding award offered to students for academic purposes, athletic achievements, or for meeting other criteria. There are scholarships available for students based on race, location, income, and other factors. Students may apply for scholarships directly through their college/university or from other institutions offering scholarship funding. Since scholarships are financial awards, students are not responsible for paying back the funding they receive.
- Fellowship Grants: A fellowship grant works similarly to a scholarship but is awarded for pursuing a specific study or research on a particular topic.
- Need-based Education Grants: Need-based education grants are funding awarded to students based on the income and financial situation of their immediate families. Pell Grants are financial assistance offered to students who show the most need for financial assistance in order to attend college/university. Usually, students do not have to pay back the financial aid they receive from Pell Grants. However, there are some circumstances where students are required to pay back Pell Grant funding. Furthermore, students may only receive Pell Grants for education from one school at a time. Other types of financial aid, such as Non-Pell Grants, work similarly to private student loans, meaning borrowers are responsible for paying back the funding they receive. Since students are required to pay back Non-Pell Grants, this type of funding is more often eligible for student loan interest deduction.
Other Ways To Save Money When Paying Off Private and Federal Student Loans
Thankfully, student loan interest deduction isn’t the only way borrowers can save money on their student loans. Below are some tips you can take advantage of to help you reduce costs when it comes to paying back private and federal student loans.
Build Healthy Financial Habits
The first step towards saving money on student loans is to set yourself up for success by building credit as a college student. In order to build credit, you will have to adopt responsible financial habits like making payments on time, reducing the amount of debt you accumulate, and avoiding unnecessary credit inquiries. Handling your finances responsibly will not only help you avoid added financial burdens like late payment fees, but it will also help put you in a position to receive approval on a wider variety of financial products and potentially lower interest rates on funding in the future.
Refinance After You Graduate
Since student loan applicants are often young and therefore don’t usually have a lot of financial history, it can be common for these borrowers to get stuck with higher interest rates, especially if they are applying for private student loans.
Depending on how well you handled your finances while in school, you may be able to save a significant amount of money on interest rates and other charges by refinancing your student loans after your graduate. It may also be possible to refinance student loans with bad credit if you find the right lender.
Try Negotiating Debt
Depending on your financial situation, you could also consider negotiating student loan debt. Negotiating debt may involve working with a debt settlement company and discussing how much loan debt you have and how much you can afford to pay back. From there, the debt settlement company can work with your various creditors to try and negotiate a lower payback amount. Keep in mind that negotiating and settling debt can have a significant effect on your credit report and credit scores, so you may want to save this option as a last resort.
Bottom Line: Deductions on Student Loan Interest Rates
While it’s possible to receive deductions when it comes to paying taxes on student loans, borrowers may be able to look forward to other types of deductions in the future.
During the COVID-19 pandemic, a student loan pause was put in place to help ease the burden of the other financial struggles so many student loan borrowers were facing at the time. The future of student loan payments and deductions also has the potential to change even more in the coming months.
Back in August of 2022, the Biden administration, along with the U.S. Department of Education, announced plans for a student debt relief program. Under this student loan debt relief plan, eligible borrowers would be able to receive loan forgiveness between $10,000 and $20,000. Borrowers with an individual annual income below $125,000 or a combined annual income of $250,000 may be eligible for debt relief of up to $10,000 for Non-Pell Grant loans and $20,000 for Pell Grant loans. Private student loans are, regrettably, not currently included in this debt relief plan.
Unfortunately, the legitimacy of this student loan relief program is still up for debate. If no decision has been made as of June 30, 2023, regular student loan payments will resume for all borrowers in the following 60 days.
To get more information on student loans, handling your finances, and more, be sure to check out the CreditNinja dojo!
Topic No. 456 Student Loan Interest Deduction | Internal Revenue Service
Tax Benefits for Higher Education | Federal Student Aid
Some borrowers may qualify for a student loan interest deduction, despite payment pause | CNBC
Publication 970 (2022), Tax Benefits for Education | Internal Revenue Service
The Biden-Harris Administration’s Student Debt Relief Plan Explained
Modified Adjusted Gross Income (MAGI)