On August 24, 2022, President Joe Biden and the U.S. Department of Education announced a three-part plan to provide relief to federal student loan borrowers. One part of the plan is to provide targeted debt forgiveness, with up to $20,000 in debt cancellation for eligible borrowers. Federal loan borrowers who received Pell Grants are eligible for up to $20,000 in debt cancellation, while non-Pell Grant recipients are eligible for up to $10,000 – as long as their individual income is less than $125,000 ($250,000 for married couples). For some, the forgiveness may wipe out all of their student loan debt. However, while their debt would be erased, it could negatively impact their credit – albeit slightly.
What is credit?
Within the U.S. financial system, credit is the ability to borrow money to access goods or services, with the understanding that the borrower will pay it back later. Credit unions, banks, and other lenders issue credit to people who want to obtain something now, but either can’t or don’t want to pay for it immediately. Before someone is granted any credit, lenders determine the borrower’s creditworthiness, or how likely they are to pay the money back in full and on time. Creditworthiness is represented by a credit score, which is a number between 300 and 850. The higher the score, the better one’s creditworthiness.
Will student loan forgiveness affect credit?
If federal student loan borrowers have their student debt completely forgiven, they may notice a dip in their credit scores. However, they shouldn’t be overly concerned about this and the dip should not deter them from applying for forgiveness.
Why might credit scores drop after forgiveness?
Holding student loans contributes to one’s credit mix – which refers to the variety of loans someone has taken. Examples include mortgage loans, auto loans, and credit cards. When lenders are deciding whether to offer someone a loan, and at what interest rate, seeing a steady payment record on a mix of credit types helps the lender because it shows that the person can manage the different obligations that come with borrowing multiple kinds of debt. So student loan forgiveness takes one kind of loan away from a person’s credit mix , which could lead to a slight, temporary dip in their credit score.
Another reason why someone might notice a slight dip in their credit scores is because student loan forgiveness may lower the average age of their credit accounts. Student loans are often the earliest loans people take out, and a longer credit history shows a person has experience using credit. This helps lenders measure the risks they take when lending to that person. Having a history of on-time payments indicates that someone is likely to make their payments on time if a lender gives them credit. However, despite any slight dip in credit scores, the financial benefits of forgiveness outweigh the minimal dip.
Could forgiveness improve some borrowers’ scores?
If someone receives the student loan forgiveness, but that does not completely erase their entire balance, they may notice a credit score improvement. This is because the student loans are still contributing to their credit mix and to the average age of their credit accounts. Eliminating a portion of their debt decreases the amount owed to lenders – and how much is owed is the second biggest contributing factor to credit scores. If someone is using a lot of their available credit, it may indicate they are overextended – making them look like they have a higher risk of failing to pay their debts. Student loan forgiveness of $10,000 or $20,000 will lower their amounts owed, potentially leading to increased scores.
So what is the bottom line?
The bottom line is that student loan forgiveness is well worth it. The possibility of a quick dip in one’s score should not make people worried about seeking loan forgiveness. If forgiveness negatively impacts someone’s score, it will probably only be a 5- to 10-point drop. As long as people keep making their other loan payments on time, their score can rebound relatively quickly, usually within three to six months. The amount of money saved from receiving debt forgiveness far outweighs any temporary impact on credit!