Canceling a student loan could temporarily hurt your credit, but that doesn’t mean you should worry about it.
President Joe Biden’s plan will forgive up to $20,000 in student loan debt for qualified borrowers. If you qualify for forgiveness, the plan can put thousands of dollars back in your pocket. But in addition to the benefits of lowering your monthly payments and potentially paying off your loans faster, there’s at least one downside worth knowing about, even if it’s temporary.
Your credit score could take a negative hit due to how certain rating factors are affected by changes to your accounts. Luckily, this will only affect your score for a short time. Plus, you’ll only see your score drop when you close your loan accounts, meaning you won’t be affected if you owe more than is forgiven.
“You might feel a little dip in your score, but I wouldn’t worry because over time it will bounce back,” says Beverly Harzogcredit card expert and consumer credit analyst for US News and World Report.
Here’s exactly how student loan forgiveness can affect different factors that go into your credit score, and how you can maintain great credit despite short-term successes.
How loan forgiveness can impact your score
Student loan forgiveness has a big impact on three factors that make up your credit score or ability to apply for loan products: credit mix, age of account history, and debt-to-income ratio.
Credit profiles and the scores associated with them are complex and personal, so it can be difficult to generalize how student loan forgiveness will affect everyone’s scores, says Justin Hake, vice president of communications for the Consumer Data Industry Association. “Removing or suspending student loan information from credit reports will have a unique impact on consumer credit scores.”
Much of it depends, he says, on how the various credit score factors relate to your individual credit history.
Age of credit history
The longer you have a credit history, the better. And for many Americans who took out student loans as young adults entering college, those loans may be the oldest accounts on their credit reports.
The age of your credit accounts isn’t the most important factor in your score — it makes up about 15% of your FICO credit score — but it can be affected when your accounts close, especially older ones.
However, the drop is temporary and paying off your loan in full is worth it.
Composition of credit
The credit combination represents 10% of your FICO credit score, although this may be the factor most affected by student loan forgiveness.
Student loans (as well as other personal loans with regular payments over a period of time) are a type of installment loan. On your credit report, installment loan accounts differ from revolving accounts, such as a credit card or home equity line of credit (HELOC). In general, it helps your score to have a mix of installment and revolving account types.
If student loans are the only type of installment loan account on your credit report, closing them could lead to a bigger drop in your credit score. If you have another installment loan, like a mortgage, car loan or personal loan, Harzog says, you won’t see much of a change.
Many borrowers have student loan debt above the $10,000 forgiveness limit (or $20,000 for borrowers eligible for the Pell Grant). Your credit composition is only affected when closing an account. So if the forgiveness isn’t enough to close your student loan account, you won’t have to worry about the effect on the credit mix until you pay off your loans in full.
Debt to income ratio
The credit impact of canceling student loans is not entirely negative. In fact, getting thousands of dollars in debt forgiveness can also improve your score, increasing your chances of being approved for more types of credit or loans in the future.
This is because a lower debt balance can improve your debt-to-income ratio (DTI), or the amount of your income that goes to pay your debt each month. The lower your DTI, the more you will turn to a lender because you have more income available to take on new debt, such as a mortgage payment.
How Student Loan Forgiveness Won’t Affect Your Credit
For all of the credit factors influenced by student loan forgiveness, there are also key ways that won’t make a difference.
The two most influential rating factors
Payment history and credit usage are the most important factors in your credit score, accounting for 65% of your overall FICO score. In most cases, student loan forgiveness doesn’t have much of an effect on either of these factors.
Payment history reviews your record of regular payments on all of your open accounts on time and in full each month. However, missed or late payments hurt your payment history. So while it’s not affected by loan forgiveness, it’s a good idea to make a plan for any remaining loan payments you still owe before the repayment pause ends in early 2023.
“Paying your bills on time is the most important thing,” says Harzog. “If you still have a student loan to pay, pay it diligently, pay it on time. This helps build your credit score and increase it.
When it comes to credit usage — or the ratio of existing debt to your available credit — how that factors into your score depends a lot more on how you use credit cards, Harzog says. Installment accounts don’t count toward usage, but you can maintain good credit by keeping credit card balances low.
Past credit errors
Missing a payment or paying late can negatively affect your credit score. If you’ve made a mistake with your student loans in the past and it’s been flagged on your credit, student loan forgiveness won’t erase it.
“He will stay there for seven years,” says Harzog. “Everyone makes a mistake from time to time… If it’s correct, you can’t remove it from your credit report and just wait.”
These flagged errors also tend to have less impact the further you get from the date they appeared on your credit report, she says. “Just promise to have good credit habits in the future, and your score will eventually bounce back.”
Keep in mind that this does not apply to suspension of student loan payments in response to the pandemic. These missed payments do not negatively impact your score, as long as you start paying the remaining balance when the break is lifted next year.
In the end, erasing a large chunk of student loan debt is well worth the relatively minor — and temporary — effects on your credit score.
“It’s good for people who qualify. But I don’t think it’s going to suddenly raise or lower your score drastically. And over the next three to six months, everything will probably balance out anyway.
The most important thing for good credit is to practice good credit habits consistently over time. Paying your account balances in full and on time each month, without spending more than you can afford, can help you build and maintain excellent credit.