The Biden administration’s sweeping plan to cancel up to $20,000 in student debt for tens of millions of Americans may have an unintended, though hopefully temporary, consequence for some people, experts say.
“For many borrowers, it will cause their credit scores to drop,” said higher education expert Mark Kantrowitz.
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Here’s why: Throughout the three-year pause on federal student loan payments, borrowers’ accounts have been reported to the credit bureaus as current, Kantrowitz said. (Payments are currently scheduled to restart by September.)
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On-time payments help boost people’s scores.
“Payment history is the most important factor in the credit scoring formula,” said Ted Rossman, senior analyst at Bankrate.com.
If the Supreme Court rules that the relief plan is legal and can go into effect, however, millions of borrowers will have their student debt balances wiped out entirely and lose out on that positive reporting, Kantrowitz said.
Of course, a temporary dip in credit score will not likely matter much to someone getting thousands of dollars in debt forgiveness. Also, those who still have a balance after the cancellation won’t see a drop if they pay their bills on time.
And although the relief may lower scores a bit, having less debt ultimately helps your rating, Rossman said. That’s because owing less improves your so-called debt-to-income ratio, he said.
Lenders look at this ratio when deciding how much to let you borrow. Some use something called the 28/36 rule, which specifies that no more than 28% of your monthly gross income go toward housing costs, and no more than 36% go toward total debts. (A few mortgage lenders have even higher caps.)
“So overall, I see student loan forgiveness as a significant benefit to someone’s overall financial situation, even if their credit score may decline a little bit in the short term,” Rossman said.
Focus on paying down other debt
Despite the possible ding to borrowers’ credit scores, another benefit to those who get their student loans forgiven will be the chance to pay down other debt faster, Rossman said.
With the average credit card interest rate at record highs, he said, “it’s important to make credit card debt payoff a priority.”
“Any extra money you can funnel toward this debt can also improve your credit score as a result,” Rossman added.
If the Biden administration is able to proceed with student loan forgiveness, Rossman said he expects the relief to show up on credit reports within a month or two. He recommends you 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, Kantrowitz said.