Ah, the sweet relief of having student loans forgiven. It feels like having the weight of the world lifted off your shoulders — that is, until you realize that it might come at a cost to your credit score.
With student debt cancellation gaining momentum, it's important to weigh the pros and cons before taking the plunge. After all, your credit score is like your financial GPA — and nobody wants to flunk out of the credit game. A poor credit score could impact your ability to borrow money, the interest rates you'll get, your chances of landing a job, acquiring insurance, securing a rental property, and more.
Critics argue that cancelling student debt could potentially come at a cost to lenders' credit scores. What does that mean for you? Read on to find out.
What's Happening With Student Loan Forgiveness
Though rumors of student loan forgiveness have been swirling around for years, it wasn't until recently that it seemed like a real possibility. The Biden administration's student loan forgiveness proposal (currently blocked by the Supreme Court) aims to cancel $10,000 of federal student loan debt for each borrower (and up to $20,000 for Pell Grant recipients). Supporters argue that it could provide much-needed relief to millions of Americans burdened by student loan debt.
Earlier this year, the Supreme Court heard arguments on whether the Biden administration has the authority to cancel student debt. Despite the administration's hope for a positive outcome, the court's ruling could take months, it said. Meanwhile, the pause on student loan repayments will end regardless of the decision. According to the administration, the pause will expire 60 days after the Supreme Court makes a decision on the case. “If no decision has been made by June 30, 2023, payments will resume 60 days after that,” the Education Department stated in a mass email to borrowers.
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Could Forgiveness Negatively Impact My Credit Score?
While student loan forgiveness will provide relief for many borrowers, it may result in a temporary credit score drop. When student loans, which are considered "installment loans," are forgiven, they are typically marked as "paid in full" or "settled" on credit reports. This can cause a borrower's credit score to drop because the account is closed, and no more payments are being made on the debt, experts say.
Despite the potential drawbacks, however, proponents of student debt cancellation argue that the benefits should outweigh the risks. For many lenders, student loan debt is a significant financial burden that can limit their ability to save for retirement, purchase a home, or start a business. By cancelling this debt, borrowers could have more disposable income to spend on other financial goals.
According to Ethan Dornhelm, the vice president of Scores and Predictive Analytics at FICO, (a data analytics company that produces FICO scores), some individuals may see a minimal drop in their credit scores, while others will see an uptick in their score as a result of recent credit reporting changes.
“The vast majority of consumers will not see the score move more than 20 points,” Dornhelm told USA Today.
How To Minimize Potential Dings to My Credit Score
While you're paying off your student loans, there are several steps you can take to minimize any negative impact to your credit score, including:
- Stay Ahead of It: Setting up reminders and automatic payments is an effective way to stay on top of your student loan payments and avoid missing payments. Missing payments can have a significant negative impact on your credit score, resulting in costly late fees and penalties.
- Read the Fine Print: Carefully reading all communication from your student loan provider can help you discover additional financial solutions and options that may be available to you. These notices may contain information on alternative payment plans, refinancing options, or other forms of relief that could help you manage your debt more efficiently.
- Look Into Other Options: Refinancing or consolidating your student loans can be another viable option to secure a more manageable monthly payment. When you refinance or consolidate, your current loans could be replaced with one that offers lower interest rate to help reduce your monthly payment.
- Reach Out to Your Loan Service: Contacting your student loan servicer can be a helpful way to discuss available options for managing your debt, such as setting up a payment plan or applying for forbearance or deferment. Your servicer may also be able to offer you guidance on how to navigate your repayment options, or provide you with other resources.
Note: Additional forbearance or deferment may require individuals to provide information regarding their financial situation, unlike the automatic deferment provided by the CARES Act during the COVID-19 pandemic, says Dornhelm.
The Bottom Line
While some people could see a minimal drop in their credit score due to student loan forgiveness, most will see a rise in their score. Still, borrowers should carefully consider the impact on their credit scores before pursuing loan forgiveness and, when in doubt, consult with a financial advisor to see what your best course of action is.
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