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Just a few weeks ago, President Joe Biden announced his decision on broad federal student loan forgiveness was coming soon.
If you’re one of the millions of borrowers who are waiting to see if any of your student debt will be canceled, it’s a good time to think of the implications that sweeping loan cancellation would have on both your credit score and your finances overall.
Below, Select spoke with Travis Hornsby, founder of Student Loan Planner, to learn more about what federal student loan borrowers can expect.
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Your credit score may slip slightly, but don’t worry
If you’ve ever pulled your credit report, you’ve likely seen your student loans listed on there as a type of installment loan. This is a good thing, as it shows your student debt actually adds to your mix of credit. Lenders like to see a variety of credit — both revolving and installing credit — because it illustrates that a borrower can manage the different obligations that come with borrowing all kinds of money.
For this reason, paying off an installment loan such as student debt can actually ding your credit score since it lessens your overall credit mix. Hornsby says not to worry, though. The dip in your credit score will be only temporary and it’s likely to go back up within several months.
“Overall, loan forgiveness is a fantastic thing,” Hornsby tells Select. “Focus on getting the loan forgiveness, and any kind of impact to your credit score is going to be insignificant.”
The only exception here that Hornsby points out is if student loan forgiveness happens at around the same time you’re making a big-ticket purchase, such as a house or a car. If you’re planning to borrow money to finance a new home or vehicle, you may want to consider getting pre-approved so your credit score is as high as possible when you go to apply.
The bottom line here is if student loan forgiveness does end up happening, your credit score will likely be impacted, but only briefly and barely — as in a 5- to 10-point drop.
Hornsby adds that he most often sees people focusing on credit scores to their detriment, but when it comes to loan forgiveness, you shouldn’t worry about any temporary changes to your credit score.
There’s a way to instantly raise your credit score
If you find yourself worrying about your credit score often, consider checking out *Experian Boost™, a free feature that lets you add your on-time phone, internet, cable, utility (gas, electricity, water) and streaming payments to your Experian credit report. According to Experian’s website, average users receiving a boost reported a 13-point increase in their FICO® Score.
How student loan forgiveness could impact your finances
Having, say, $10,000 of student loans erased from your debt balance would certainly impact your finances in a good way. That’s $10,000 you’re off the hook for and would no longer need to pay.
According to Hornsby, though, there are other positive — and negative — financial outcomes when it comes to having all or a portion of your student loans forgiven. Here are some things to consider.
Your debt-to-income ratio will go down
A large debt load, such as thousands of dollars in student loans, increases what’s called your debt-to-income ratio, or DTI. A high DTI can make it more difficult to borrow money in the future since it indicates that the amount you owe exceeds the amount you’re making. When student loans are forgiven, however, this lowers your DTI, narrowing the gap between your outstanding debt and income.
You may get a refund
For federal student loan borrowers who continued making payments throughout the pandemic-induced payment and interest freeze — which is currently still in effect through Aug. 31, 2022 — there’s a chance they may be eligible for a refund once loans are forgiven, Hornsby says.
You could owe more in taxes
It’s possible that you may be required to pay taxes on the amount of student debt that is forgiven. That is, however, dependent on the type of student loan forgiveness you receive, Hornsby indicates. For example, income-driven repayment, or IDR, forgiveness is currently tax-free through the end of 2025.
Any negative payment history may remain on your credit report
Whether student loan forgiveness completely wipes out your remaining student debt or just a portion of it, your payment history from those student loans will likely remain on your credit report. That’s good news if you have a solid history of making on-time monthly student loan payments, but not so good news if you haven’t been consistent.
Hornsby adds, however, that it’s possible negative marks and late payments would be taken off your report following loan forgiveness, yet, this is not certain. Late payments typically appear on your credit report and stay there for seven years.
This is important to note because one’s payment history is the most important factor in their credit score, making up a 35% chunk of their credit score calculation. A good payment history can seriously help keep your credit score high, while a poor payment history can seriously hurt it.
While we still don’t know how President Biden’s broad student loan forgiveness will (or won’t) play out, you can rest assured knowing that any forgiveness is a good thing overall. Even if debt cancellation may ding your credit score five or so points, it wouldn’t be for long and the positive financial implications of forgiveness we believe outweigh any negative results.
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*Results may vary. Some may not see improved scores or approval odds. Not all lenders use Experian credit files, and not all lenders use scores impacted by Experian Boost.
Publisher Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
George is Digismak’s reported cum editor with 13 years of experience in Journalism