The Biden administration’s plan to cancel up to $20,000 in student debt for tens of millions of Americans may have an unintended consequence of lowering their credit score. As for many borrowers, it will cause their credit scores to drop.
Let me explain why student loan forgiveness can still be beneficial for borrowers despite the potential short-term negative impact on their credit scores. During the three-year hiatus on federal student loan payments, borrowers’ accounts have been reported to credit bureaus as current, which can help boost their credit scores since payment history is the most crucial factor in credit scoring.
However, if the Supreme Court permits the relief plan to go into effect, millions of borrowers will have their student debt balances wiped out entirely, which means they will lose out on that positive reporting.
Nevertheless, a temporary drop in credit score is unlikely to matter much to someone who will receive thousands of dollars in debt forgiveness. Moreover, those who still have a balance after the cancellation won’t see a decline in their credit score if they continue to make timely payments.
Furthermore, while loan forgiveness may lower scores somewhat, having less debt ultimately helps borrowers’ credit rating in the long run, as it improves their debt-to-income ratio. Lenders use this ratio to determine how much they can lend you. For instance, some lenders follow the 28/36 rule, which stipulates that no more than 28% of your monthly gross income should go toward housing expenses, and no more than 36% should go toward total debts.
Therefore, even if student loan forgiveness results in a short-term reduction in credit scores, it can still provide a significant financial benefit to borrowers in the long run.
Focus on paying down other debt
Although student loan forgiveness may have a detrimental effect on borrowers’ credit scores, another advantage for those who receive it is the opportunity to repay other debts more quickly.
Given that the average interest rate on credit cards has exceeded 20%, it is critical to prioritize paying off credit card debt. Therefore, any additional funds that can be allocated to reduce this debt can lead to an improvement in the borrower’s credit score.
If the Biden administration is able to proceed with student loan forgiveness, then we should expect the relief to show up on credit reports within a month or two. I would also recommend you to check your report regularly for free at AnnualCreditReport.com to make sure all three credit rating companies — Experian, Equifax and TransUnion — are showing the correct information, including a possibly lower student debt balance.
If the Biden plan doesn’t survive the Supreme Court, the resumption of student loan bills should not affect borrowers’ credit scores as long as they remain current.
