Student loan forgiveness programs offer great financial relief especially when you are struggling financially. But before you celebrate, you need to know how your credit score gets affected when your student loan is forgiven. In the long term, your credit score will go up if your student loan is forgiven due to carrying less debt. Student loan forgiveness, however, can lead to a short-term decrease in your credit score.
This is because student loan forgiveness can directly impact your credit mix which is a factor in your credit score calculations. In addition, the age of your active credit account could go lower which might lower your credit score. The good news is that as you use your credit accounts responsibly, pay your bills on time, and manage your credit utilization, your score will rebound in no time.
Will my credit score go up if my student loan is forgiven?
When your student loan is forgiven, your credit score will be impacted. Since your credit mix is one of the factors that affect your credit score, you might see a slight decrease in your credit score once your student loan is forgiven. A good credit mix should include revolving credit, and installment credit accounts such as mortgages, student loans, car loans, personal loans, etc.
Depending on the number and types of accounts you have, your student loan forgiveness can weaken your credit mix. This in turn will have a temporary decrease in your credit score.
In long term, your credit score will go up when your student loan is forgiven. This is because once your student loan is forgiven, the number of debts and the amount you owe will go lower. This in turn will lower your debt-to-income ratio.
An improved debt-to-income (DTI) ratio will boost your credit scores. By default, your credit score goes lower as the amount of debt you carry increases. The lesser debt you carry the easier you can pay off your debts which makes you a less risky borrower. People who carry a lot of debt are susceptible to default or having late payments. That is why your credit score goes lower as the amount of debts you carry goes higher.
In short, your credit score will go increase when your student loan is forgiven. But you might see a temporary decrease in your credit score due to a disruption in your credit mix or the age of your credit.
Types of student loans forgiveness
- Teacher loan forgiveness (TLF). After 5 years of consecutive and complete teaching at a qualified school, the TLF forgives up to $17,500 of your Direct and Federal Stafford Loans, according to the Federal Student Aid.
- Public service loan forgiveness (PSLF). After making 120 qualifying payments or roughly 10 years of payments, The PSLF forgives the remaining balance on your Direct Loans.
- Federal income-based repayment (IBR) programs. This program helps low-income earners to make affordable payments by lowering their payments up to 15% of their income. The repayment plans can be extended up to 25 years. Read about this program for more details from the Student Aid website.
How does student loan forgiveness affect your payment history?
One misconception about loan forgiveness is that people think their payment history will also disappear once their student loans are forgiven. The contrary is true. Your payment history reflects your loan payment behavior over the years. So, if you made your payments on time, these activities would remain even if your loans were forgiven.
Negative items such as late payments or delinquencies will also stay on your credit reports. As a result, your score will continue to be affected by these records on your credit reports after your student loan is forgiven.
Student loan forgiveness can lower the age of your active credit history
Both the FICO score and Vantage score treat the age of your credit as an important factor in your credit score calculations. When a credit account such as a student loan or credit card is closed, your credit score goes lower temporarily due to shortening your active credit history.
According to TransUnion, closing an old account can affect your credit age and lower your credit score. For this reason, if your student loan is forgiven and also one of your oldest accounts, your credit score might slightly go lower to reflect these changes. Your score will then rebound as you pay off your bills on time and use remaining accounts responsibly.
How does student loan forgiveness affect your finances?
Although student loan forgiveness sounds great and gives you financial relief, it might come with extra financial obligations. Some student loan forgiveness programs treat the amount you were forgiven as an income. In other words, you end up paying tax on the forgiven amount. Depending on the amount that was forgiven, you could end up in a higher tax bracket which will result in a much higher tax liability when filing your tax returns.
How to avoid student loans?
Student loans are very accessible and easy to qualify for. But it might not be a good idea to finance your entire college education with student loans. Not only that you graduate with loans on your shoulder, but it is also hard to get ahead financially after graduation.
The good news is that there are some clever financial tips you can use to entirely avoid student loans. The following are effective tips to help you cover your entire college without taking out expensive loans.
- Work while in school. Any extra cash you make can help you cover your living expenses, tuition, fees, and food.
- Start out with community college. Community colleges are easy to qualify for and cost a fraction of what universities and colleges cost.
- Take time off between high school and college. This time will allow you to work and raise the money you need for your college.
- Apply for scholarships. Universities and colleges have different scholarships that you can apply for. If you have a good GPA, apply for teaching assistantships and research assistantships. Also look into other programs you can qualify for. Every little bit helps.
- Accelerate your studies. Instead of spending 4 years or more in college, consider accelerated programs. By finishing your programs faster, you will end up lowering the cost of your education.
- Go to instate schools. In state schools tend to cost less money than out of state schools.
- Apply for government grants.
Another option that works for some people is to take time off between semesters or years. This option is not recommended but it works. Another important factor to consider while attending college is to live in a cheaper apartment. You can also live with many other people to further lower your living expenses.