Why Student Loan Forgiveness Could Hurt Your Credit Score

After months of suspense, it’s finally official: the Biden administration will forgive up to $20,000 in federal student loan debt for eligible borrowers.

Some 43 million Americans will be impacted by the plan, the Department of Education estimates, including about 20 million borrowers who will see their entire loan balances disappear.

While this is obviously great news for borrowers, changes to their student loans could also mean a change – most likely a temporary decrease – in their credit scores.

The impact is likely to be minor for most people, but this will depend on the individual situation. Here’s everything you need to know.

Your credit combination will change

If you’re one of the 20 million borrowers whose student loans would be entirely forgiven thanks to Biden’s plan, you could see your credit score drop a little at least in the short term.

This is because student loans contribute to what is called your credit mix. Your credit mix refers to the different types of loans you have, from revolving debt like credit cards to installment debt like student loans, car loans, and mortgages. Lenders like to see a variety of credit types, and eliminating one type from your profile could negatively impact your score.

Your credit composition is only 10% of your FICO score, which is a type of credit score that lenders use to assess your creditworthiness (VantageScore is another major score used by lenders).

Any drop in your score due to a change in your credit mix should be minimal and probably won’t make or break you when it comes to getting new loans down the line. The likelihood of a slight drop in your credit score, however, is worth considering if you’re planning to finance a major purchase like a house or car in the immediate future.

Your credit history could be shorter

The other thing that could lower your score is a change in the average age of your credit accounts. Student loans are often one of the oldest loans Americans have because most people take them out when they are still teenagers.

Closing on these long-standing loans could hurt your credit score, as lenders tend to prefer borrowers with longer credit histories. The length of your credit history makes up 15% of your FICO score.

The good news is that as long as you continue to make your other loan payments on time, your credit score can rebound quite quickly, and in all likelihood, the temporary impact on your score won’t outweigh the benefits of the loan. elimination of debt.

Your credit score could increase

For some people, student loan forgiveness might actually result in a higher credit score. In fact, eliminating up to $20,000 in debt could be a significant decrease in your total debt balance, which represents 30% of your FICO score.

A lower debt balance can result in a higher credit score, but other factors come into play. FICO also takes into account your total credit utilization, which is the total amount of your available revolving credit that you use at some time. Your credit utilization rate includes credit card debt, but excludes installment debt like student loans.

When could your credit score change?

The student loan cancellation application will not be available until early October, according to the Ministry of Education. After your request, it can take up to six weeks for the pardon to take effect. Any change in your credit score will happen afterwards.


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