What Are Forgivable Loans?

It sounds great: a loan you don't have to pay back. A borrower doesn't have to repay a forgivable loan as long as she meets any conditions attached to it by her lender. Not only will the borrower of a forgivable loan see the money she borrows effectively turn into a grant, she typically won't have to spend money on expensive interest payments.

A forgivable loan works as a carrot to persuade a borrower to behave in a certain way. Organizations that offer forgivable loans do so with strings attached. These require borrowers to fulfill certain responsibilities and adhere to certain restrictions if the money they owe is going to be forgiven. Failure to meet the terms of a forgivable loan contract will mean a borrower having to repay what he borrowed, usually with interest.

Forgivable loans are often used by governments and other organizations in education and training to give students a nudge toward working in jobs considered challenging or hard-to-fill when they graduate. Student loans for those planning to teach are frequently written off if they agree to spend a certain number of years working in environments such as inner cities or with pupils who have challenging behavior patterns. Medical graduates might have their student loans forgiven if they agree to work for charitable organizations or in a geographical area where their skills are needed.

Some state housing departments and charitable organizations offer forgivable loans to homeowners who need repair work carried out at their properties. Funds made available under these programs are typically offered to low-income households or those living in certain areas, and they are usually forgiven only if borrowers stay in their properties for a set period of time and meet other conditions.

Many employers use forgivable loans as a retention tool to help them keep top talent. Big companies often pay high-profile new recruits a signing bonus in the form of a forgivable loan, which they get to keep if they stay in their post for a specified period. If they jump ship to a new company, they have to pay their loan back. Forgivable loans are usually taxable, so any such payment would count as income as far as the IRS is concerned.

You should know upfront whether a loan is forgivable. Contact your lending firm if you are unsure whether you have a forgivable loan.