Experts say the Biden administration’s broad plan to forgive up to $20,000 in student debt for tens of millions of Americans may have unintended, if hopefully temporary, consequences for some people.
“For many borrowers, it will cause their credit scores to drop,” said higher education expert Mark Kantrowitz.
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.)
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.
However, if the Supreme Court rules that the relief plan is legal and can be implemented, millions of borrowers will have their student debt balances completely erased and will lose out on the positive reporting, according to Kantrowitz.
Of course, a temporary drop in credit score is unlikely to matter much to someone receiving thousands of dollars in debt relief. Those who have a balance after the cancellation will not see a reduction if they pay their bills on time.
And, while debt relief may temporarily lower your credit score, having less debt will ultimately help your score, according to Rossman. This is because owing less improves your debt-to-income ratio, he explained.
Lenders consider this ratio when determining how much money you can borrow. The term “responsibility” refers to the act of determining whether or not a person is responsible for the actions of another person. (A few lenders have even higher limits.)
“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.