- The Biden administration is forgiving up to $20,000 in debt for some federal student loan borrowers.
- All state student loans are marked as current on credit reports while there is a two-year pause in payments.
- Paying off educational debt in full could easily hurt your credit score.
The Biden administration’s sweeping federal student-loan forgiveness plan means millions of borrowers will have full education debt forgiveness, which may impact their credit scores.
Under President Biden’s plan, individual borrowers earning less than $125,000 annually will have $10,000 of their federal student loan debt forgiven. The amount of forgiveness is $20,000 for those who went to college with Pell Grants.
Payments on federal student loans have been suspended for more than two years as part of government efforts to mitigate the economic impact of the COVID-19 pandemic. Borrowers are marked as current on their loans since the start of the repayment pause, even if they have not actually made any payments.
What does student loan forgiveness mean for your credit score?
Student loan forgiveness does not have a major impact on the creditworthiness of most borrowers.
“In most cases, the loan forgiveness should be neutral or possibly slightly positive for a borrower’s creditworthiness, although there may be exceptions based on individual circumstances,” said Chris Ebeling, head of student lending at Citizens Bank.
“Although forgiveness doesn’t have a major impact on a borrower’s rating, it could have other benefits once repayment resumes, such as: ‘ said Ebeling.
However, it can actually negatively impact the creditworthiness of some borrowers.
Your credit score is calculated based on a variety of factors, including the number of accounts you have, the types of accounts you have, the amount of available credit you’ve used, the length of your credit history, and your payment history.
When you close an account, you decrease the length of your credit history, and this can be especially problematic if a student loan is one of your oldest accounts. You can expect your credit score to improve when you pay off a loan. However, if you remove it from your credit profile, the average age of your accounts will go down, which can lower your score.
Additionally, your credit mix accounts for 10% of your credit score and is made up of both revolving and installment loans. Revolving credit includes things like credit cards and home equity lines of credit. Examples of installment loans include car loans, personal loans, mortgages, and student loans. Lenders want to see you manage multiple types of credit responsibly, so a mix of both types of credit can improve your score.
If you don’t have other installment loans when you close your student loan account, your credit score could be affected as your loan mix shifts. While your score might drop initially, the negative impact will be relatively minor and unlikely to last long, as eliminating this debt can ultimately help you improve your overall credit profile.
How to find out your creditworthiness
You can find your credit report for free on annualcreditreport.com from each of the three major credit reporting agencies weekly through the end of 2022. While this report doesn’t give you your credit score, it does show you information about your credit and payment history that lenders use to decide whether to extend credit to you. Reviewing your credit report can help you identify what you need to improve.
You may be able to find your points balance for free on your credit card statement or online account. There are also a number of websites like Credit Karma and Credit Sesame that offer credit scores if you sign up for their free services.
Credit scores range from 300 to 850. Here’s how FICO scores break down:
- Very poor: 300 to 579
- Industrial fair: 580 to 669
- Good: 670 to 739
- Very good: 740 to 799
- Exceptionally: 800 to 850
How to improve your credit score
If you’re looking to improve your score after your loan is forgiven, here are some tips you might consider to improve your credit score:
- Request and review a copy of your credit report. Look for errors in your report that could hurt your score. If you find any, contact the credit bureau to discuss correcting the errors.
- Maintain a low credit card balance. A credit utilization rate — the percentage of your total loan that you use — of 30% or less will prove to lenders that you are managing your loan appropriately.
- Create a system for paying bills on time. Your payment history makes up a significant percentage of your credit score, and lenders prefer to see consistent and reliable past payments. Design calendar reminders or automatic payments so you don’t fall behind.
The final result
While some borrowers may take a short-term hit to their creditworthiness following student loan forgiveness, the financial benefits far outweigh any negative effects.
“For those who would have difficulty in paying off their debts on time due to various circumstances such as B. Difficulty finding a job after graduation, student loan forgiveness can have a big impact,” Gabe Krajicek, CEO of fintech community banking company Kasasa, said.
“Student loan forgiveness means you no longer have to worry about money being taken from your monthly income. Late payments can negatively impact your credit score, which can lead to financial problems in other areas of your life.”
