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

admin by admin
August 26, 2022
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How Biden’s student loan forgiveness could impact your credit score
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President Joe Biden announced broad student loan forgiveness of up to $10,000 to $20,000 for most federal borrowers Wednesday. That’s good news—even though it might cause recipients’ credit scores to temporarily dip.

Multiple factors make up a credit score in the U.S., including total credit usage—also known as credit utilization rate or ratio—and mix of credit. When a loan is forgiven or paid off, the mix of credit declines. That means, at least in the short term, your score may drop a few dozen points if your balance is wiped out by the forgiveness plan.

Unless you’re immediately applying for a product that checks your credit score, that may not be a huge issue. Your score will rebound as long as you’re paying everything else on time and not taking out another massive loan. Credit mix comprises 10% of a FICO credit score—there are more important factors to worry about, including paying all of your bills on time and keeping your utilization rate low.

“Paying off student loans…can actually lower your score a bit,” says Matt Schulz, chief credit analyst at LendingTree. “The good news is that the ding should be small, won’t last long, and can be outweighed by the financial benefits of having all that debt go away, as long as you handle your other bills wisely.”

That said, it all depends on your personal financial situation.

“A few points can be no big deal or the difference between approval and rejection,” says Schulz. “Everyone’s situation is different, but it is something to consider” if you’re planning to apply for a mortgage, auto loan, or new credit card in the near future.

More importantly, your credit utilization rate will also go down. For most people, that’s good news. And as Schulz alluded to, having $10,000 to $20,000 less in debt is better for your financial health overall (especially considering what you will save on interest).

“A lot of debt will be removed from peoples’ credit profiles, giving them a boost,” says Jacob Channel, an economist at Student Loan Hero. “That will make it easier to qualify for a mortgage.”

But that won’t necessarily be a huge boost. Bringing a balance down on an installment loan “doesn’t help you nearly as much as if you paid down $10,000 in revolving debt,” such as on a credit card, says Ted Rossman, senior industry analyst at Bankrate. “Your credit utilization ratio on those revolving accounts plays a much greater role than your balances on installment loans.”

That said, “I think student loan forgiveness could only help your credit score…a lower installment loan balance could only help,” he says.

Rossman also notes that more people have been potentially impacted by the payment pause on federal student loans. If borrowers are paying their student debt off more quickly, or saving $250 per month, on average, and putting that toward other debt, then their score has likely improved over the past 30 months.

“A lot of people used those funds to pay down credit card debt, which would definitely improve your credit score, and to keep up with other bills and also to save more,” he says.

It’s also helped some borrowers avoid delinquencies, since they aren’t being punished for late payments, Rossman adds. That’s directly helped some credit scores.

And when payments resume in the new year, the so-called Fresh Start program will allow millions of borrowers with loans previously in default to reenter repayment in good standing. That will make a significant difference for those borrowers.

“Lower loan balances and reduced delinquencies created by student loan forgiveness and the ongoing payment pause would only help,” he says.

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