President Biden’s recent student loan forgiveness plan will bring relief to millions of borrowers dealing with heavy debt loads and costly interest expenses. But could a payoff HURT your credit?
The truth is a little murky. Here’s what you need to know:
However, this will only be the case if student loan forgiveness pays off the entire student loan balance. This is because a loan payoff can affect two factors that make up your credit score: credit age, and credit mix.
The temporary dip on your score could be caused by the effect of paying off a loan that counts toward your credit age. Your credit age tells lenders how long you’ve been using credit. It’s usually determined, or heavily influenced, by the age of your oldest OPEN credit account.
For many, student loans are a consumer’s first and oldest credit account. When an account is paid, it is also closed. Because credit bureaus do not factor closed accounts into a consumer’s credit age, the borrower’s score may take a slight hit sometime after the student loan balance is paid off.
Your credit mix accounts for around 10% of your credit score. A consumer’s credit mix consists of the different types of credit accounts they have open. Having more than one type of credit looks good to lenders, but having only one type of credit may affect your score negatively.
A diverse mix of accounts would include both installment loans and revolving lines of credit.
Installment loans, such as student loans or a car payment, feature consistent monthly payments in the same amount made toward a predetermined balance. Revolving credit, such as credit cards, feature monthly payments that can fluctuate and a line of credit that can be borrowed against at any time.
Student loan forgiveness could negatively impact your credit mix IF your student loan is your only installment loan, and your loan is paid in full. This is because paying the balance in full will close the account, and the installment account would no longer benefit your credit mix.
For a few individuals, the dip could be problematic. For example, if you’re in the process of closing on a mortgage loan, even the slightest change to your credit score can upend your plans.
However, in the vast majority of cases, the benefits of student loan forgiveness will outweigh the temporary slip in your score. In the short-term, you’ll have more room in your budget for saving and investing. In the long-term, you’ll pay far less interest over time. Both of these effects are healthy for your personal finances and for your credit score overall.
Learn more: Do You Qualify for Student Loan Forgiveness?
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The StellarFi blog is intended to serve as an informational resource. While StellarFi can help you build your credit, we do not provide financial, legal, or accounting advice. Please consult a trusted advisor for financial, legal, or accounting guidance as needed.