How student loan forgiveness can affect your credit score

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Student debt can make it harder for people to start a business or buy a home — and one reason is that lenders are considering your existing financial obligations.

After President Joe Biden announced plans to cancel millions of student loan borrowers up to $20,000, many people will find a more favorable balance sheet and possibly improved credit ratings.

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Biden said in late August that most federal student loan borrowers are entitled to some forgiveness: up to $10,000 if they haven’t received a Pell Grant, a type of grant for low-income undergraduate students, and up to $20,000 if they don’t receive a Pell Grant. if you did. Meanwhile, other recent changes for student loan borrowers, including a second chance for those who have defaulted on their loans, could put them in an even better financial position.

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Here’s what it could all mean for your credit.

Don’t expect a “big” impact on your credit score

Student loan forgiveness is likely to have little impact on your credit score, said Ted Rossman, a senior industry analyst at CreditCards.com.

“I don’t think it’s going to be huge,” Rossman said.

That’s because student loans are considered “installment loans,” meaning a loan that you pay back with regular payments over a set period of time. These are not weighted too heavily in yours Credit utilization rate, which is how much of the credit you have available you use, he explained. Your usage rate can account for up to 30% of your score.

Still, each score boost can help you get better terms from other lenders.

President Biden announces student loan debt relief plan

Less debt can help you qualify for more credit

Having less debt on your student loans will improve your “debt-to-income ratio,” which is the portion of your monthly income that is used to pay off your existing debt.

Lenders consider this ratio when making the decision how much you let borrow. Some apply the so-called 28/36 rule, which says no more than 28% of your gross monthly income goes toward housing costs and no more than 36% goes toward overall debt. (Some mortgage lenders have even higher limits.)

Forgiveness that reduces or even eliminates your monthly student loan payments could lower that ratio and “potentially help you qualify for a larger mortgage, car loan, or credit card limit,” Rossman said.

Credit report changes can take months after the application

Currently the US Department of Education saying the loan cancellation request will be available by early October, and borrowers could see the relief within six weeks.

Borrowers can then expect their reduced or paid off debt to show up on their credit reports within about three months, Rossman said.

When you have less debt, you can make better progress on paying off credit card debt and increase your savings and investments.

TedRossman

Senior Industry Analyst at CreditCards.com

He recommends that you regularly check your report for free on AnnualCreditReport.com to ensure all three credit scoring companies – Experian, Equifax and TransUnion – are showing your correct account balance. You can check your credit report weekly for free until the end of 2022.

Make sure you keep a record of your reduced debt from your student loan administrator in case you need it as evidence.

Defaulting borrowers have the option to delete their records

The Ministry of Education also has recently announced that it will bail out around 7 million student loan borrowers from their defaults.

Once the so-called “Fresh Start” program kicks off, borrowers will begin selecting a repayment plan at MyEdDebt.Ed.Gov or by calling the Department of Education’s Default Resolution Group at 800-621-3115, said higher education expert Mark Kantrowitz.

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Your loans should then be transferred to a new servicer from Maximus, the servicer handling the defaulted federal student loans. Once you have a new servicer and are enrolled in a payment plan, the outage should automatically be erased from your records, Kantrowitz said.

The opportunity is temporary. Borrowers have a one-year window to switch to a new repayment schedule, starting when the Covid-19 payment suspension ends. This is currently scheduled to happen on December 31st.

New payment plans could also help borrowers’ credit ratings

Along with President Joe Biden’s announcement last week on student loan forgiveness, he said the Department of Education will look to offer a new offering to borrowers with student loans income-based repayment plan that could cut their monthly bills in half. The plan could reduce average annual student loan payments by more than $1,000, according to the White House.

Kantrowitz said this could have “a big impact on mortgage underwriting” because the other monthly financial obligations you have are a big consideration for lenders.

The plan is not yet available to borrowers, but they should continue to check for updates.

You can also use a lower or eliminated monthly student loan payment to meet your other financial goals, Rossman said.

“Having less debt will help you make more progress on paying off credit card debt and increase your savings and investments,” he said.

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