Why Student Loan Forgiveness Could Hurt Your Credit Score
After months of suspense, it's finally official: The Biden Administration will forgive up to $20,000 in federal student loan debt for eligible borrowers.
Some 43 million Americans will be impacted by the plan, the Education Department estimates, including roughly 20 million borrowers who will see the entire balance of their loans disappear.
While this is obviously great news for borrowers, changes to their student loans could also mean a change — quite possibly a temporary decrease — to their credit scores.
The impact is likely to be minor for most people, but it will depend on the individual situation. Here's everything you need to know.
Your credit mix will change
If you're one of the 20 million borrowers whose student loans would be wiped out entirely thanks to Biden's plan, you might see your credit score fall a little bit — at least in the short term.
That's because student loans contribute to what's known as your credit mix. Your credit mix refers to the different types of loans you have, from revolving debt like credit cards to installment debt like student loans, car loans and mortgages. Lenders like to see a variety of credit types, and eliminating one type from your profile could have a negative impact on your score.
Your credit mix only accounts for 10% of your FICO score, which is one type of credit score that lenders use to assess your creditworthiness (VantageScore is another major score lenders use).
Any drop in your score due to a change in your credit mix should be minimal and probably won't make or break you when it comes to securing new loans down the line. The likelihood of a slight dip in your credit score is worth keeping in mind, however, if you're planning to finance a major purchase like a house or a car in the immediate future.
Your credit history could get shorter
The other element that might lower your score is a change in the average age of your credit accounts. Student loans are often one of the oldest loans Americans have, since most people take them out when they're still teenagers.
Closing those longstanding loans could be bad for your credit score since lenders tend to prefer borrowers with longer credit histories. The length of your credit history accounts for 15% of your FICO score.
The good news is that as long as you keep making your other loan payments on time, your credit score can rebound relatively quickly, and in all likelihood the temporary hit to your score won't outweigh the benefits of eliminating the debt.
Your credit score might rise
For some people, student loan forgiveness could actually lead to a higher credit score. That's because eliminating up to $20,000 in debt could constitute a major decrease in your total debt balance, which accounts for 30% of your FICO score.
A smaller debt balance can lead to a higher credit score, but there are other factors at play. FICO also considers your total credit utilization, which is the total amount of your available revolving credit that you're using at a given time. Your credit utilization ratio includes debt from credit cards but excludes installment debt like student loans.
When could your credit score change?
The student loan cancellation application won't be available until early October, according to to the Education Department. After you apply, it could take up to six weeks for the forgiveness to take effect. Any changes to your credit score will happen after that.
More from Money:
Student Loan Forgiveness Timeline: When Will You Actually Get Debt Relief?
Student Loan Forgiveness: Here's Who Qualifies Under Biden's Plan