How Student Loan Forgiveness Could Impact Your Credit Score

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Student debt can make it harder to start a business Where buy a house – and one of the reasons for this is that lenders take into account your existing financial obligations.

Now that President Joe Biden has announced plans to forgive up to $20,000 for millions of student borrowers, many people will end up with a better track record and possibly an improved credit score.

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Biden said in late August that most federal student loan borrowers would be eligible for some remission: up to $10,000 if they didn’t receive a Pell grant, which is a type of aid available to undergraduates. low-income cycle, and up to $20,000 if they did. Meanwhile, other recent changes coming for student borrowers, including a second chance for those who haven’t repaid their loans, could leave them in even better financial shape.

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Applications for student loan forgiveness could open within weeks

Here’s what all of this could mean for your credit.

Don’t expect a “huge” effect on your credit score

Student loan forgiveness will likely have a modest impact on your credit score, said Ted Rossman, senior industry analyst at CreditCards.com.

“I don’t think it will be huge,” Rossman said.

This is because student loans are considered “installment loans”, meaning a loan that you repay over a period of time with regular payments. These don’t weigh too heavily in your credit utilization rate, which is how much of the credit you have you use, he explained. Your usage rate can represent up to 30% of your score.

However, any score increase may help you secure more favorable terms with other lenders.

President Biden announces student debt relief plan

Less debt can help you qualify to borrow more

Owing less on your student loans will improve your “debt-to-income ratio,” which is the portion of your monthly income used to pay off your existing debts.

Lenders take this ratio into account when deciding how much you can afford to borrow. Some use what is called the 28/36 rule, which specifies that no more than 28% of your gross monthly income is spent on housing costs and no more than 36% in total on debts. (A few mortgage lenders have even higher limits.)

Forgiveness that reduces or even eliminates your monthly student loan payments could lower that ratio, “potentially helping you qualify for a mortgage, car loan, or larger credit card limit,” says Rossman.

Credit report changes can take months after application

Currently, the US Department of Education saying the loan cancellation application will be available in early October, and borrowers could see relief within six weeks.

Borrowers can then expect to see their debt reduced or cleared on their credit reports within about three months, Rossman said.

Owing less will help you make further progress in paying off your credit card debt, which will increase your savings and investments.

Ted Rossman

Senior Industry Analyst at CreditCards.com

He recommends that you regularly check your report for free on AnnualCreditReport.com to ensure that the three credit rating companies – Experian, Equifax and TransUnion – are showing your correct balance. You can check your credit report every week for free until the end of 2022.

Be sure to keep a record of your reduced debt with your student loan officer in case you need it as proof.

Borrowers in default have the possibility of erasing their file

The Ministry of Education has also recently announced that it would help some 7 million student borrowers out of default.

Once the so-called “Fresh Start” program launches, borrowers will begin by choosing a repayment plan at MyEdDebt.Ed.Gov or by calling the Department of Education’s Default Resolution Group at 800-621-3115, said higher education expert Mark Kantrowitz.

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Your loans must then be transferred from the servicer who handles federal student loans in default, Maximus, to a new servicer. Once you have a new repairer and are signed up for a payment plan, the default should be automatically wiped from your record, Kantrowitz said.

The opportunity is temporary. Borrowers will have a one-year window to switch to a new repayment plan, starting when the Covid-19 suspension of payments ends. This is currently set to happen on December 31.

New payment plans could also help borrowers’ credit

Along with President Joe Biden’s announcement last week about canceling student loans, he said the Department of Education is preparing to offer borrowers with undergraduate loans a new income-driven repayment plan that could cut their monthly bills in half. The plan could reduce the average annual student loan payment by more than $1,000, according to the White House.

Kantrowitz said this could have “a big impact on mortgage underwriting” because other monthly financial obligations you have are very important to lenders.

The plan is not yet available to borrowers, but they should keep checking for updates.

You can also take advantage of a lower or eliminated monthly student loan payment to move forward on your other financial goals, Rossman said.

“Having less will help you make more progress paying off your credit card debt, which will increase your savings and investments,” he said.