An Unexpected Benefit of Student Loan Forgiveness: A Better Credit Score

There are several student loan forgiveness programs, including Public Service Loan Forgiveness (PSLF), Teacher Loan Forgiveness, and the newly implemented Saving on a Valuable Education (SAVE) plan. Loan forgiveness doesn't remove accounts from a credit report. Instead, the loans will be paid in full, and a borrower's debt-to-income (DTI) ratio will improve.

In the event a borrower defaults on a federal loan, President Biden’s Fresh Start program can potentially remove the default from their credit report, and defaulted loans would show “in repayment,” which can also increase your score.

Student Loan Forgiveness Programs

Several types of student loan forgiveness programs apply only to federal student loans and include:

• Public Service Loan Forgiveness (PSLF): Under PSLF, federal loan borrowers can qualify for debt forgiveness if they work full-time for a nonprofit organization or government agency for at least ten years and make 120 qualifying monthly payments.
• Teacher Loan Forgiveness: Those who teach in low-income schools or education service agencies for at least five consecutive academic years can qualify for up to $17,500 of federal loan forgiveness.
• Income-Driven Repayment (IDR) Forgiveness: With IDR plans, borrowers may qualify for reduced payment based on their discretionary incomes. If the borrower still has a balance at the end of the repayment term, the remainder is then forgiven. There are currently four IDR plans: the Pay As You Earn (PAYE) plan, the Income-Based Repayment (IBR) plan, the Income Contingent Repayment (ICR) plan, and the SAVE plan.

In August 2023, President Biden unveiled the SAVE Plan, which replaces the older REPAYE plan. SAVE is an IDR plan that calculates a monthly payment based on income and family size, eliminates the need for a spousal co-signer, and excludes compounding of unpaid interest as payments are made. In addition, loans are eligible for forgiveness after 10, 20, or 25 years, depending on the original loan amount and time spent making payments.

Student Loan Default

Not paying student loans can lead to default. With private loans, default can begin after missing a payment for 90 days, and with federal loans, after 270 days. The consequences of default can be severe, particularly with federal student loan debt. Under normal circumstances, the federal government can garnish wages and seize tax refunds.

The default is reported to the credit bureaus, and the record of late payments will likely stay on a borrower's credit reports for up to seven years. Borrowers who see inaccuracies related to a student loan should investigate the errors to improve their credit.

Fresh Start Program

Under President Biden’s Fresh Start program, borrowers with federal student loans in default could drastically improve their credit. Defaulted student loans would be removed from the credit report, and the loans would appear on a credit report as “in repayment.”

Private student loans are not eligible for forgiveness. The only way to remove the default is to pay the accounts off in full. Borrowers can use a creditworthy co-signer to pay off the loans and refinance the loans with another lender.

How Student Loan Forgiveness Affects a Credit Score

The impact of student loan forgiveness depends greatly on a borrower's unique credit profile. Some may see a slight dip, but forgiveness will have a net positive effect for most.

• Defaulted loans: Under the terms of the Fresh Start program, defaulted student loans are removed from credit reports, and the loans are listed as “in repayment.”
• Credit mix: Those who qualify for loan forgiveness may see their scores drop by a few points if the student loan was their only installment loan, as their credit mix (i.e., the different types of credit accounts they have) accounts for 10% of their FICO Score.
• Age of credit: The length of a borrower's credit history makes up 15% of their credit score. If the student loan is the oldest account, paying it off can cause a score to decrease.
• Amounts owed: When your student loan balance decreases, your credit utilization ratio drops, helping your score. Credit utilization accounts for 30% of a credit score.

Credit Report Disputes

Part of good credit hygiene is checking your report regularly to ensure the information is accurate, since errors may drag your score down. Look for student loans that may have been repaid but not closed, or if you are using the Fresh Start program, check to make sure your loans are now listed as in repayment. Accurate information cannot be removed, but if there are errors on a credit report, borrowers can dispute those inaccuracies and have them removed. You can file a dispute online with each of the major credit bureaus:

• Equifax
• Experian
• TransUnion

Borrowers can also send a dispute letter to their loan servicer. The letter should include the name and account information of the loan with inaccuracies and details about why it should be removed. A sample letter is available from the Consumer Financial Protection Bureau (CFPB).

The Bottom Line

Although loan forgiveness can impact a credit score, the effect is often temporary. And for borrowers with federal student loans in default, the Fresh Start program could give them a clean slate, removing the default from their credit reports.