The White House plan to cancel $10,000 to $20,000 student loan debt for borrowers earning $125,000 or less per year could have a big impact on many American households – around 43 million borrowers will be eligible for debt cancellation and 20 million will have their loans fully repaid.
While removing that student loan debt from your balance sheet might be good for you and your monthly budget in the long term, it could have an unexpected effect on your credit score in the short term. Here’s what we know about the impact canceling your student loan could have on your credit score.
To find out more, check out the the biggest red flags for spotting student loan forgiveness scams and the last on the student loan payment break extension.
What is the difference between a credit report and a credit score?
Credit bureaus — Equifax, Experian and TransUnion are the big three — collect financial information from your creditors to create credit reports.
Credit bureaus can use these reports to create credit scores that ostensibly reflect your creditworthiness — and help companies decide both whether to lend you money, for example, and what interest rate to charge you. Banks may use their own scoring systems to determine whether to offer you a mortgage or car loan.
Credit scores, including the widely used FICO score, can be calculated using pieces of information contained in your credit report:
- Payment the story, detailing how and when you paid your accounts over the term of your credit
- Amounts you owe on your accountsincluding the amount of your available credit that you use
- Length of your credit historyincluding the age of your oldest and newest accounts and the average age of all your accounts
- Composition of creditincluding credit cards, retail accounts, installment loans and mortgages
- New credit you recently opened
Here is more about what goes into determining credit scores.
Could canceling my student loan debt affect my credit rating?
For many student borrowers, credit scores won’t be significantly affected, Martin Lynch, director of education at Cambridge Credit Counseling, told CNET.
Borrowers who made payments on time and for whom debt forgiveness covers the full amount of their loans might see a slight uptick in their scores, Lynch said.
On the other hand, if a loan was in default when it was canceled, under the old FICO models that are still in use, a credit score could drop. Lynch said the latest FICO scoring models ignore a paid collection account, so a score wouldn’t suffer with the new calculation method.
Lynch said borrowers with what he calls “thin credit profiles” — those with few credit accounts and little diversity in the credit mix they carry — could see a drop in their scores. And if a borrower doesn’t have other installment loans, eliminating the student loan (which is a type of installment loan) could negatively impact their score, he said.
Borrowers could also lose points on their credit scores if student loans are among their oldest accounts, Lynch said, because removing them would change the average age of all their credit accounts.
So if it might temporarily hurt my credit rating, should I ignore student loan forgiveness?
No. Focusing on the negative impact of the score, he misses the boat, Lynch said: “Having thousands of dollars of debt forgiven will be more significant for most student loan holders.”
With the economy looks shaky, money saved from canceled student loan repayments can be used for other purposes, such as building up savings. And if you see a drop in your score, Lynch said, you can also use some of the money you’ve saved from debt forgiveness to improve your scores by expanding your credit profile or paying off debts. balances of your revolving accounts such as credit cards.
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