- The Biden administration is canceling up to $20,000 in debt for some federal student loan borrowers.
- All federal student loans are marked current on credit reports in the middle of a two-year payment break.
- It could have a slightly negative impact on your credit score if it wipes out the student loan debt entirely.
The Biden administration’s sweeping federal student loan forgiveness plan means millions of borrowers will have their student loan debt forgiven entirely, which can impact their credit scores.
Under President Biden’s plan, individual borrowers earning less than $125,000 a year will have $10,000 of their federal student loan debt forgiven. The rebate amount will be $20,000 for those who went to college on Pell Grants.
Federal student loan payments have been suspended for more than two years as part of the government’s efforts to mitigate the economic impact of the COVID-19 pandemic. Borrowers have been marked up-to-date on their loans since the start of the repayment pause, even though they have not actually made any payments.
What does student loan forgiveness mean for your credit score?
Student loan forgiveness will not have much effect on the credit scores of most borrowers.
“In most cases, loan forgiveness should be neutral or potentially slightly positive for a borrower’s credit score, although there may be exceptions based on individual circumstances,” said Chris Ebeling, head of student loans at Citizens Bank.
“While the discount does not have a major impact on a borrower’s score, it could have other benefits once repayment resumes, such as the borrower’s ability to access new credit, as many lenders take into account total monthly debt payments, in addition to credit score,” Ebeling said.
However, this can actually negatively impact the credit scores of some borrowers.
Your credit score is calculated using a variety of factors, including the number of accounts you have, types of accounts, the amount of available credit you’ve used, the length of your credit history, and your payment history. .
When you close an account, you reduce the length of your credit history, which can be especially problematic if a student loan is one of your oldest accounts. You can assume that your credit score improves when you pay off a loan. But in effect, when 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 is 10% of your credit score and consists of both revolving credit and installment credit. Revolving credit includes things like credit cards and home equity lines of credit. Examples of installment credit include car loans, personal loans, mortgages, and student loans. Lenders like to see that you can responsibly manage multiple types of credit, so keeping a mix of both types of credit can boost your score.
If you don’t have any other installment loans when your student loan account is closed, your credit score could suffer because your credit mix will change. Although your score may drop initially, the negative impact will be relatively small and likely won’t last long as eliminating that debt can ultimately help improve your overall credit profile.
How to find your credit score
You can find your credit report for free at annualcreditreport.com from one of the three major credit bureaus every week until the end of 2022. Although this report does not give you your credit score, it will show you information about your credit and payment history, which lenders use to decide whether or not to grant you a loan. Reviewing your credit report can help you know what you need to improve.
You may be able to find your free score on your credit card statement or online account. There are also a number of websites, such as Credit Karma and Credit Sesame, that offer credit scores when you sign up for their free services.
Credit scores range from 300 to 850. Here’s how the scores break down, according to FICO:
- Very poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very well: 740 to 799
- Exceptional: 800 to 850
How to improve your credit score
If you want to improve your score after canceling your loan, here are some tips you might think about to improve your credit score:
- Request and review a copy of your credit report. Look for any errors on your report that could hurt your score. If you find any, contact the credit bureau to discuss correcting the errors.
- Maintain low credit card balances. Having a credit utilization ratio – the percentage of your total credit that you use – of 30% or less will prove to lenders that you can manage your credit appropriately.
- Create a system to pay bills on time. Your payment history makes up a large 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 bottom line
While some borrowers may see their credit score take a short-term hit after student loan forgiveness, the financial benefits far outweigh any negative impact.
“For those who would have struggled to repay their debt in a timely manner due to various circumstances, such as difficulty finding work after graduation, student loan forgiveness can have a big impact” , said Fintech CEO Gabe Krajicek. community-bank-enterprise Kasasa, said.
“Student loan forgiveness means you no longer have to worry about money being taken out of your monthly income, late payments can negatively impact your credit score, which can lead to financial hardship in d ‘other areas of life.’