The White House plan to cancel $10,000 to $20,000 in student loan debt for borrowers earning $125,000 or less per year could have a big impact on many American households -- about 43 million borrowers will be eligible for debt cancellation, and 20 million will have their loans completely paid off.
While removing that student loan debt from your balance sheet may be a good thing for you and your monthly budget in the long term, it could have an unexpected effect on your credit score in the short term. Here's what we know about how canceling your student loan debt could impact your credit score.
For more, learn the biggest red flags for spotting student loan forgiveness scams and the latest on the extension of the student loan payment pause.
What's the difference between a credit report and a credit score?
Credit bureaus -- Equifax, Experian and TransUnion are the big three -- collect financial information from your creditors to create credit reports.
Credit bureaus can use these reports to create credit scores that ostensibly reflect your creditworthiness -- and help businesses decide both whether to lend you money, for example, and the interest rate to charge you. Banks may use their own scoring systems to determine whether to offer you a mortgage or an auto loan.
Credit scores -- including the widely used FICO score -- can be calculated using pieces of information in your credit report:
- Payment history, detailing how and when you've paid your accounts over the length of your credit
- Amounts you owe on your accounts, including how much of your available credit you are using
- Length of your credit history, including the age of your oldest and newest accounts and the average age of all your accounts
- Credit mix, including credit cards, retail accounts, installment loans and mortgages
- New credit you've recently opened
Here's more on what goes into determining credit scores.
Could canceling my student loan debt affect my credit score?
For many student-loan borrowers, credit scores won't be dramatically impacted, Martin Lynch, director of education at Cambridge Credit Counseling, told CNET.
Borrowers who have made payments on time and for whom debt forgiveness covers the full amount of their loans could see a slight bump in their scores, Lynch said.
On the other hand, if a loan was in default when it was canceled, under older FICO models that are still in use, a credit score could dip. Lynch said that the latest FICO scoring models ignore a paid collection account, so a score wouldn't suffer with the newer method of calculations.
Lynch said borrowers with what he calls "thin credit profiles" -- those with few credit accounts and not much diversity in the mix of credit they carry -- could see a drop in their scores. And if a borrower lacks other installment loans, eliminating the student loan (which is a type of installment loan) could negatively impact their score, he said.
Borrowers could also lose points on their credit scores if the student loans are among their oldest accounts, Lynch said, because removing them would change the average age of all their credit accounts.
So if it might temporarily hurt my credit score, should I skip student loan forgiveness?
No. Focusing on the negative score impact is missing the boat, Lynch said: "Having thousands of dollars of debt forgiven is going to be more important for most student loan holders."
With the economy looking wobbly, money saved from forgiven student loan payments can be put to another use -- such as building up savings. And if you do see a drop in your score, Lynch said, you could also use some of the money you saved through the debt forgiveness to improve your scores by broadening your credit profile or paying down balances on your revolving accounts such as credit cards.
For more, here are the best budget apps and what to know about inflation.