How Does Student Loan Forgiveness Affect Credit?

Student loan debt has become quite an issue in the U.S. lately, as borrowers have collected over $1.6 trillion in student loan debt while pursuing higher education. It’s become such a hot-button issue that it’s even entered the political arena.

In 2022, the Biden administration unveiled its plan to relieve up to $20,000 in outstanding student loan debt per borrower. The maximum of up to $20,000 is for those with a Pell Grant. Those who didn’t qualify for a Pell Grant may get up to $10,000 in relief.

But the Biden administration’s plan isn’t the only student loan debt relief program on the books. There are various relief options for people working in certain jobs and those earning smaller incomes. 

If you’re seeking student loan cancellation, a common question running through your head may be, “How does student loan forgiveness affect credit?” We answer this and other student loan debt relief questions below.

Does student loan forgiveness affect credit?

Yes, because your student loan debt appears on your credit report as an installment loan with a balance, having them forgiven will affect your credit score and overall creditworthiness. So, how does student loan forgiveness affect credit? Let’s take a look.

Amounts owed decreases

The first impact student loan forgiveness has is on the amounts owed variable of the FICO® credit score algorithm. This variable has a total weight of 30% of your credit score, but the bulk comes from your credit utilization ratio. Your credit utilization ratio only considers revolving debts, such as credit cards and lines of credit.

Since student loans are an installment debt, student loan forgiveness will have a small impact on your amounts owed variable and may slightly boost your FICO Score. But don’t expect a night-and-day difference like you would if you paid off a high-utilization credit card.

Delinquency resolution

If your student loan debt was delinquent when the pandemic-fueled student loan payment freeze began, and your loan was included in those that were frozen, you likely noticed all collection activity stopped. This was part of the rules put in place by the freeze.

Under President Joe Biden’s student loan forgiveness program, these delinquent federal student loans that were frozen will also likely qualify for loan cancellation of up to $20,000. If that forgiveness wipes out your balance, you will also have no more delinquent balance.

This doesn’t mean all your past late payments will disappear though. All it means is the account will be a $0 balance, which could improve your credit score or at least make lenders more willing to work with you.

Keep in mind that the Biden administration’s student loan debt cancellation plan only impacts federal student loan borrowers, not private student loans. So, if you have both federal and private student loans, and the latter are in delinquency, this loan forgiveness won’t help you bring them current. 

Lower debt-to-income ratio (DTI ratio)

While a lower DTI ratio — the percentage of your monthly income that goes toward making monthly debt payments — will not increase your credit score, it does improve your creditworthiness in many lenders’ eyes. If student loan forgiveness leaves you with a lower or no balance, your DTI ratio will also fall.

With a lower DTI ratio, you have a better chance of getting approved for a higher loan amount or a lower interest rate when applying for other loans, like auto loans or mortgages.

More free income

While it’s not directly related to student loan debt forgiveness, having less going toward student loan payments each month leaves you with more cash to apply toward other debts. If you apply this extra cash toward high-interest credit card debt, you can reduce it more quickly, improving your credit utilization ratio and boosting your credit score.

If you don’t have credit card debt, you can still lower other non-student-loan debts more quickly and potentially increase your score.

When should student loan borrowers expect to see credit score improvements?

When applying for any type of student loan forgiveness through the government, there will be a delay between application time and you seeing any credit score improvements. 

For example, with the Biden student loan forgiveness, even if 100% of your student loan balance is eligible to be wiped out, seeing any credit score improvements could take months after applying. According to the Department of Education, the Biden student loan forgiveness plan application opens in October 2022, and it could take four to six weeks for borrowers to get relief.

Plus, you likely won’t see the changes impact your credit report until your loan servicer’s next reporting date to the three major credit bureaus, which could be up to a month after loan forgiveness. So, even if it takes only four weeks to approve your forgiveness application, you could have to wait another month until that forgiveness hits your credit profile.

You can expect similar delays when applying for debt under other programs, such as those for teachers or nurses. For example, when it comes to the Public Service Loan Forgiveness (PSLF) Program, processing can take up to 90 days.

If you need proof your loan was forgiven before the new balance hits your credit history, you can contact your loan servicer and ask if it offers a statement or letter outlining the debt relief and your new balance. You can give this to a lender to show you will have a lower DTI ratio.

Are there tax implications in student loan debt forgiveness?

Yes, there is one big thing to consider in student loan debt forgiveness, but it’s unrelated to your credit score. And that is, you may owe state and federal income tax on any forgiven debt.

This taxation issue may impact income-driven repayment plans (IDR plans) that forgive any remaining student loan debt after 20 to 25 years of on-time payments. IRS rules require that any student loan debt relief received under an IDR plan is added to your annual income for that year.

For example, if you earned $40,000 per year and had $10,000 in student loan debt relief under an IDR plan, your income in that tax year would be $50,000.

Keep in mind that the American Rescue Plan temporarily changes these rules. All student loan debt relief between 2021 and 2025 will not count toward your income, including IDR plans, thereby having no impact on your taxes.

States that follow federal taxation guidelines on forgiven debt will follow the American Rescue Plan rules. However, some states have unique taxation rules and may still collect state income tax on any forgiven student loan debt. 

Student loan forgiveness may help your credit

While student loan forgiveness won’t play a significant role in improving your credit score directly, it can have a small impact. It also improves your overall creditworthiness by lowering your DTI ratio and making it easier to qualify for an auto loan, mortgage or other loans. 

Plus, it can indirectly impact your FICO Score by freeing up more cash that you can put toward paying down credit card debt.

If you’re ready to tackle credit card debt, the Tally† credit card debt repayment app can help. The app helps you manage your credit card payments, and Tally offers a lower-interest personal line of credit, allowing you to efficiently pay off higher-interest credit cards. 

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.