Potential impacts on credit scores after student debt forgiveness
The U.S. Department of Education recently announced that it will discharge the federal student loans some borrowers. See how the discharge of federal student loans will affect your credit score.
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The U.S. Department of Education recently announced that it will discharge the federal student loans of over 550,000 individuals, who borrowed to attend any campus owned or operated by Corinthian Colleges Inc.
To date, the Department has now approved $25 billion in loan forgiveness for 1.3 million borrowers. This is likely to grow as providing targeted relief to help reduce or eliminate student loan debt to struggling borrowers is a major focus of the Biden administration.
So what does it mean for your credit score if your student loan debt is discharged and is now being reported with $0 balance?
It may result in the score going up, down or no change in score. The exact impact of student loan debt forgiveness on a consumer's credit score will depend on the specifics of the particular discharge proposal, as well as the consumer's individual credit report information – including the extent of their activity on installment loans. An installment loan is a type of loan where you borrow a set amount of money all at one time. You then repay the loan over a fixed number of payments, called installments. Student loans are usually reported as installment type loans.
A FICO® Score is designed to be predictive of a consumer's credit risk. Data shows that consumers who have active installment loans in good standing are more likely to repay their credit obligations than consumers with no active installment loans. This is reflected in a person's FICO Scores.
FICO® Scores weigh the amounts paid down and balances of mortgage and non-mortgage installment loans (such as student and auto loans) against the original loan amounts. In general, when an installment loan is first obtained the balance is high. As the loan is paid down and the balance decreases, there may be a positive impact on the score. However, analysis of credit data shows that having a low installment loan balance to loan amount ratio is even less risky than having no active installment loans at all. As a result, if the only active installment loan being reported is a student loan, paying off the remaining balance on that student loan (or having the balance discharged) can result in a decrease in score.
While no longer having an active installment loan in good standing on a credit report does remove a data point demonstrating active, regular, on-time payments, causing some consumers' FICO® Scores to see a temporary dip, it is certainly still possible for such consumers to retain a high FICO Score. In addition, many of those people will see their scores rebound over time as long as they continue to demonstrate positive credit behaviors such as on-time payments and a manageable level of overall debt.
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Tom Quinn is the Vice President of Business Development for myFICO and has over 25 years of experience working with consumers, regulators, and lenders regarding credit related questions and initiatives.