How Student Loan Forgiveness Could Affect Your Credit Score

Student Loan
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Student debt can make it difficult for people to start a business or buy a home, and one reason is that lenders take into account your existing financial obligations.

Now that President Joe Biden has announced that he plans to pay off up to $20,000 for millions of student loan borrowers, many people will find themselves with a more favorable balance sheet and possibly an improved credit score.

Biden said in late August that most federal student loan borrowers will be eligible for forgiveness: up to $10,000 if they didn't receive a Pell Grant, which is a type of aid available to low-income college students, and up to $20,000 if they did. they made. Meanwhile, recent changes coming to student loan borrowers, including a second chance for those who defaulted on their loans, may leave them in even better financial shape.

Here's what all of this could mean for your credit.

Don't Expect a "Huge" Effect on Your Credit Score

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

"I don't think it's huge," Rossman said.

This is because student loans are considered "installment loans," which means a loan that you pay back over a set period with regularly scheduled payments. Those aren't heavily weighted in your credit utilization ratio, which is how much of the credit available to you you're using, he explained. Your utilization rate can represent up to 30% of your score.

Still, any score increase can help you get more favorable terms with other lenders.

Less debt can help you qualify to borrow more

Owing less to 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 debts.

Lenders look at this ratio when deciding how much to borrow from you. Some use something called the 28/36 rule, which specifies that no more than 28% of your gross monthly income goes toward housing costs and no more than 36% goes toward total debt. (Some mortgage lenders have even higher limits.)

Forgiveness that lowers or even eliminates your monthly student loan payments could lower that ratio, "potentially helping 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 says that the loan discharge application will be available in early October and that borrowers could see relief within six weeks.

Rossman said that borrowers can then expect to see their debt reduced or erased on their credit reports within about three months.

Owing less will help you get further toward paying off credit card debt, increasing your savings and investments.

Ted Rossman
SENIOR INDUSTRY ANALYST AT CREDITCARDS.COM

He recommends that you check your report regularly for free at AnnualCreditReport.com to make sure all three credit reporting companies (Experian, Equifax, and TransUnion) show your correct balance. You can check your credit report weekly for free until the end of 2022.

Be sure to keep a record of your reduced debt from your student loan servicer in case you need it for proof.

Delinquent borrowers have the opportunity to expunge their record

The Department of Education has also recently announced that it will help some 7 million student loan borrowers out of default.

Once the so-called "Fresh Start" program is launched, borrowers will get started by choosing a repayment plan on MyEdDebt.Ed.Gov or by calling the Department of Education's Default Resolution Group at 800-621-3115, the expert said. higher education Mark Kantrowitz.

Credit Score
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Then, your loans must be transferred from the servicer that handles delinquent federal student loans, Maximus, to a new servicer. Once you have a new administrator and are enrolled in a payment plan, the breach should automatically be cleared from your record, Kantrowitz said.

The opportunity is temporary. Borrowers will have a one-year window to switch to a new payment plan, after the Covid-19 suspension of payments ends. That is scheduled for December 31.

New payment plans could also help borrowers' credit

Along with President Joe Biden's announcement last week about student loan forgiveness, he said the Department of Education was moving to offer borrowers with college loans a new income-based repayment plan that could lower their monthly bills. to the half. The program could reduce the average annual student loan payment by more than $1,000, according to the White House.

Kantrowitz said this could have "a huge impact on mortgage underwriting," as his other monthly financial obligations 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 take advantage of a lower or eliminated monthly student loan payment to further your other financial goals, Rossman said.

“Owing less will help you get further toward paying off credit card debt, increasing your savings and investments,” he said.


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