How Biden’s student loan forgiveness could impact your credit score

Just a few weeks ago, President Joe Biden announced that his decision on blanket federal student loan relief was coming soon.

If you’re one of the millions of borrowers waiting to see if any of your student debt will be forgiven, now is a good time to consider the implications a drastic loan forgiveness would have on your credit score and finances. in general.

Below, Select spoke with Travis Hornsby, founder of student loan plannerto learn more about what federal borrowers can expect.

If you already have pulls your credit report, you’ve probably seen your student loans listed there as a type of installment loan. This is good because it shows that your student debt is actually adding to your credit mix. Lenders like to see a variety of loans – both revolving and installment – because it shows that a borrower can handle the different obligations that come with borrowing all kinds of money.

For this reason, paying off an installment loan such as student debt can actually affect your credit score because it lowers your overall credit mix. Hornsby says not to worry, though. The drop in your credit score will only be temporary and it is likely to go up within several months.

“Overall the loan forgiveness is a fantastic thing,” Hornsby told Select. “Focus on getting the loan forgiveness, and any kind of impact on your credit score will be insignificant.”

The only exception here that Hornsby points out is if the student loan forgiveness occurs around the same time you make a major purchase, such as a house or car. If you are considering borrowing money to finance a new home or vehicle, you may want to consider getting pre-approved so that your credit score is as high as possible when you apply.

The bottom line here is that if student loan forgiveness does eventually happen, your credit score will likely be affected, but only briefly and barely – like in a 5-10 point drop.

Hornsby adds that he most often sees people focusing on credit scores to their detriment, but when it comes to loan forgiveness, you shouldn’t worry about temporary changes in your credit score. .

Having, say, $10,000 in student loans erased from your debt balance would definitely have a positive impact on your finances. That’s $10,000 that you’re off the hook for and wouldn’t need to pay anymore.

According to Hornsby, however, there are other positive — and negative — financial outcomes when it comes to having some or all of your student loans forgiven. Here are some things to consider.

Your debt ratio will decrease

Large amounts of debt, such as thousands of dollars in student loans, increase what is called your debt ratio, or DTI. A high DTI can make it harder to borrow money in the future because it indicates that the amount you owe exceeds the amount you earn. However, when student loans are forgiven, it lowers your DTI, thereby reducing the gap between your outstanding debt and your income.

You can get a refund

For federal student loan borrowers who have continued to make payments throughout the pandemic-induced payment and interest freeze — which is currently still in effect until August 31, 2022 — there is a chance they be eligible for repayment once the loans are canceled, says Hornsby.

You may owe more taxes

You may have to pay taxes on the amount of student debt that is forgiven. This, however, depends on the type of student loan forgiveness you receive, says Hornsby. For example, the income-contingent refund, or IDR, rebate is currently tax-free until the end of 2025.

Any negative payment history may remain on your credit file

Whether student loan forgiveness wipes out all or only part of your remaining student debt, your payment history for those student loans will likely remain on your credit report. That’s good news if you have a solid track record of making monthly student loan repayments on time, but not so good news if you haven’t been consistent.

Hornsby adds, however, that it’s possible for negative ratings and late payments to be removed from your report after the loan is canceled, but that’s not certain. Late payments usually show up on your credit report and stay there for seven years.

This is important to note because a person’s payment history is the most important factor in their credit score, accounting for 35% of their credit score calculation. A good payment history can seriously help keep your credit score high, while a bad payment history can seriously hurt it.

While we still don’t know how President Biden’s large student loan forgiveness will play out (or not play out), you can rest assured that any forgiveness is a good thing overall. Even though debt forgiveness can lower your credit score by around five points, it wouldn’t be for long and the positive financial implications of forgiveness outweigh the negative results, in our opinion.

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*Results may vary. Some may not see an improvement in scores or approval ratings. Not all lenders use Experian credit reports, and not all lenders use scores impacted by Experian Boost.