President Biden recently announced a plan to cancel thousands of dollars in student loan debt for many borrowers. For Americans earning under $125,000 per year (or $250,000 for married couples), the government will forgive up to $10,000 in student loan debt for certain loan types. For those who went to college on Pell Grants, which are provided to low-income students, the government will forgive up to $20,000 in student loan debt.
Up to 43 million Americans will be eligible for student loan relief, and the plan will cancel all remaining debt for about 20 million, according to the White House. Clearly, the plan is good news for many borrowers’ monthly budgets—but how will student loan forgiveness affect their credit scores?
Changes May Not Be Drastic
Student loans are a type of installment loans, which are repaid over a set period of time with regularly scheduled payments. This type of loan isn’t weighted as heavily in your credit utilization rate compared to credit cards. As a result, any change to your credit score as a result of student loan forgiveness may not be drastic.
Debt-to-Income Ratio Will Decrease
When you apply for credit, lenders consider your debt-to-income ratio; that is, the amount of debt you owe compared to your income. Many student loan borrowers report that they’re unable to get a mortgage for a home or use their credit for other large purchases because their student loan payments require such a large portion of their income.
Taking advantage of student loan forgiveness will automatically reduce a borrower’s debt number. As a result, most borrowers will have a higher amount of income available to cover new obligations. Your credit score does not include your income, but it does include the amount of debt you owe. Lenders use this figure to determine whether you can afford new debt.
When student loan debt is canceled, borrowers may see an eventual change in their credit scores. However, the change will depend on other factors in your score, such as on-time payments and overall debt.
Initial Decrease Is Possible
Student loan forgiveness may also result in a dip in your credit score, but it will probably be temporary. That’s because your student loans are part of your credit mix, or the different types of credit you have, such as credit cards, student loans, car loans, and mortgages. Lenders like to see a variety of credit types, and when you eliminate one type of credit, it could have a negative effect on your score.
Credit mix only accounts for a small percentage of your score, so any decrease should be slight. However, it’s important to know that could happen if you’re planning to make a major purchase in the near future.
Eliminating student loan debt may also affect your credit score because it may change the average age of your credit accounts. If you took out a student loan while you were still a teenager, it may be the oldest loan you have. Lenders tend to prefer borrowers with longer credit history, so the length of your credit history accounts for a portion of your score. If your student loans are erased, your active accounts portion of your credit history will be shorter.
Even if a change in your length of credit history has a negative effect on your score, it will probably be temporary. If you keep making other loan payments on time, your credit score may rebound quickly. And any temporary hit to your credit score probably won’t be enough to outweigh the benefits of canceling the student loan debt.
Changes Will Not Appear Immediately
The application for student loan forgiveness is now available online from the U.S. Department of Education. The government has said that after applying, borrowers could see debt erased within six weeks. After the debt has been canceled, it may take up to three months before the reduced debt will appear on your credit report.
If you want to keep track of how student loan forgiveness affects your credit score, it’s important to monitor your scores and reports from all three credit bureaus. If you’re not a member, try tracking your scores with ScoreSense with a 7-day trial membership.
