- The Biden administration is canceling up to $20,000 in debt for some federal student loan borrowers.
- All federal student loans have been marked as current in credit reports amid a two-year pause in required payments.
- Loan forgiveness could have a slightly negative impact on your credit score if it eliminates your education debt entirely.
The Biden administration’s sweeping federal student loan forgiveness plan means millions of borrowers will have their education debt canceled entirely, which can have an impact on their credit scores.
Under President Biden’s plan, individual borrowers making less than $125,000 annually will have $10,000 of their federal student loan debt canceled. The amount of forgiveness will be $20,000 for those who went to college on Pell Grants.
Federal student loan payments have been on pause for more than two years as part of the government’s effort to mitigate the economic impact of the coronavirus pandemic. Borrowers have been marked current on their loans since the repayment pause began, even if they haven’t actually made any payments.
What does student loan forgiveness mean for your credit score?
Student loan forgiveness won’t much of an effect on most borrowers’ credit scores.
“In most cases, loan forgiveness should be neutral or potentially slightly positive to a borrower’s credit score, although there could be exceptions based on individual circumstances,” says Chris Ebeling, head of student lending at Citizens Bank.
“While forgiveness may 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 says.
However, it may actually have a negative impact on some borrowers’ credit scores.
Your credit score is calculated using a variety of factors, including the number of accounts you have, the types of accounts, how much of your available credit you’ve used, the length of your credit history, and your payment history.
When you close an account, you’ll reduce the length of your credit history, and this may be particularly problematic if a student loan is one of your oldest accounts. You may assume 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 drop, which can reduce your score.
Additionally, your credit mix counts for 10% of your credit score and is made up of both revolving and installment credit. Revolving credit includes things like credit cards and home equity lines of credit. Examples of installment credit include auto loans, personal loans, mortgages, and student loans. Lenders like to see that you can responsibly manage multiple types of credit, so keeping a blend of the two types of credit can bolster your score.
If you don’t have other installment loans when your student loan account is closed, your credit score might take a hit because your credit mix will shift. While your score might drop initially, the negative impact will be relatively small and probably won’t last long as the elimination of that debt can ultimately help you improve your overall credit profile.
How to find your credit score
You can find your credit report for free on annualcreditreport.com from any of the three major credit bureaus weekly through the end of 2022. While this report won’t give you your credit score, it will show you information about your credit and payment history , which lenders use to decide whether to give you a loan. Reviewing your credit report can help you know what you need to improve.
You may be able to find your score at no cost 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 when you sign up for their free services.
Credit scores range from 300 to 850. Here’s how scores break down, according to FICO:
- Very poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very good: 740 to 799
- exceptional: 800 to 850
How to improve your credit score
If you want to boost your score after your loan is forgiven, 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 mistakes on your report that may be hurting your score. If you find any, reach out to the credit bureau to talk about correcting the errors.
- Maintain low credit card balances. Having a credit utilization ratio — the percentage of your total credit you’re using — of 30% or less will prove to lenders that you can aptly handle your credit.
- 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 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 pay off their debt in a timely manner due to varying circumstances, such as struggling to find work after obtaining a degree, student loan forgiveness can make a big impact,” says Gabe Krajicek, CEO of the fintech community bank company Kasasa.
“Student loan forgiveness means no longer needing to worry about money taken out of your monthly income, delayed payments can negatively impact your credit score which can result in financial struggles in other areas of life.”