Here's how Biden's student loan forgiveness could affect your credit score

President Biden announced Wednesday his long-awaited plan to forgive up to $20,000 worth of federal student loan debt per borrower.

If you're one of the millions of borrowers who are affected by this news, it's a good time to think of the implications that sweeping loan cancellation would have on both your credit score and your finances overall.

Below, Select spoke with Travis Hornsby, founder of Student Loan Planner, to learn more about what federal student loan borrowers can expect.

If you've ever pulled your credit report, you've likely seen your student loans listed on there as a type of installment loan. This is a good thing, as it shows your student debt actually adds to your mix of credit. Lenders like to see a variety of credit — both revolving and installment credit — because it illustrates that a borrower can manage the different obligations that come with borrowing all kinds of money.

For this reason, paying off an installment loan such as student debt can actually ding your credit score since it lessens your overall credit mix. Hornsby says not to worry, though. The dip in your credit score will be only temporary and it's likely to go back up within several months.

"Overall, loan forgiveness is a fantastic thing," Hornsby tells Select. "Focus on getting the loan forgiveness, and any kind of impact to your credit score is going to be insignificant."

The only exception here that Hornsby points out is if student loan forgiveness happens at around the same time you're making a big-ticket purchase, such as a house or a car. If you're planning to borrow money to finance a new home or vehicle, you may want to consider getting pre-approved so your credit score is as high as possible when you go to apply.

The bottom line here is that your credit score will likely be impacted, but only briefly and barely — as in a 5- to 10-point drop.

Hornsby adds that he most often sees people focusing on credit scores to their detriment, but when it comes to loan forgiveness, you shouldn't worry about any temporary changes to your credit score.

Having $10,000 of student loans erased from your debt balance would certainly impact your finances in a good way. That's $10,000 you're off the hook for and would no longer need to pay.

According to Hornsby, though, there are other positive — and negative — financial outcomes when it comes to having all or a portion of your student loans forgiven. Here are some things to consider.

Your debt-to-income ratio will go down

A large debt load, such as thousands of dollars in student loans, boosts what's called your debt-to-income ratio, or DTI. A high DTI can make it more difficult to borrow money in the future since it indicates that the amount you owe exceeds the amount you're making. When student loans are forgiven, however, this lowers your DTI, narrowing the gap between your outstanding debt and income.

You may get a refund

It has been confirmed that federal student loan borrowers who continued making payments throughout the pandemic-induced payment and interest freeze — which is now in effect through Dec. 31, 2022 — will be eligible for a refund.

You could owe more in taxes

Thanks to the American Rescue Plan of 2021, student loan forgiveness is tax-free through 2025 on a federal level, though you may owe state taxes.

Any negative payment history may remain on your credit report

Whether student loan forgiveness completely wipes out your remaining student debt or just a portion of it, your payment history from those student loans will likely remain on your credit report. That's good news if you have a solid history of making on-time monthly student loan payments, but not so good news if you haven't been consistent.

Hornsby adds, however, that it's possible negative marks and late payments would be taken off your report following loan forgiveness, yet, this is not certain. Late payments typically appear on your credit report and stay there for seven years.

This is important to note because one's payment history is the most important factor in their credit score, making up a 35% chunk of their credit score calculation. Good payment history can seriously help keep your credit score high, while a poor payment history can seriously hurt it.

This is the first time student loans are being forgiven on a widespread scale so there still are some unknowns. However, you can rest assured knowing that any forgiveness is a good thing overall. Even if debt cancellation may ding your credit score five or so points, it wouldn't be for long and the positive financial implications of forgiveness we believe outweigh any negative results.

Just remember that this announcement doesn't affect anyone with private student loans. If you currently have private student loans, consider refinancing them for a lower interest rate and better terms with a lender like SoFi or KeyBank.

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*Results may vary. Some may not see improved scores or approval odds. Not all lenders use Experian credit files, and not all lenders use scores impacted by Experian Boost.

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