How Student Loan Forgiveness Can Impact Your Credit Score

Student loan forgiveness has been a hot topic as of late, and for a good reason. Having your student loan debt wiped out is a dream come true for most borrowers. As of April 2022, more than 944,000 borrowers have applied for Public Service Loan Forgiveness (PSLF). That number doesn't include those that have taken advantage of other loan forgiveness programs like Teacher Loan Forgiveness or IDR loan forgiveness.

Not only can your financial situation change by having your loans forgiven, but so can your credit score. In most cases, your credit score won't change dramatically if your debt is wiped out, but it can still affect your credit positively and negatively. Here's a look at some ways that student loan forgiveness can impact your credit score.

How to know if you qualify for student loan forgiveness

You can qualify for some form of student loan forgiveness if you have federal student loans. There are specific federal student loan forgiveness programs that are only available to select federal borrowers, like :

• Public Service Loan Forgiveness (PSLF)
• Teacher Loan Forgiveness
• Perkins Loan Cancellation
• State-specific loan forgiveness programs

If you don't qualify for a specific program, you can also qualify for loan forgiveness through IDR loan forgiveness. This involves moving your federal loans over to an Income-Driven Repayment Plan. After 20 to 25 years of qualifying payments, the government forgives the remaining loan balance.

Are private student loans forgiven?

Private lenders generally don't offer student loan forgiveness. It's near impossible to get your private loan debt forgiven. There's also no way to convert your private loan to a federal loan to take advantage of government programs.

The closest option to loan forgiveness you have with private loans is to refinance your private loans to a lower interest rate. Yes, you still end up paying off your loan, but you can potentially lower your monthly payments or cut thousands of dollars off of your total debt by paying less interest over the life of your loan. It's not the same as having your loan forgiven, but it's still a money saver if your credit is good enough to qualify for lower interest rates.

Student loan forgiveness impact on credit score

Once your loan balance is paid off, your financial situation may change considerably. Here's a look at some ways that student loan forgiveness may impact your finances going forward.

Your loan balance will drop to $0

Perhaps the biggest change you'll notice is that zero next to your outstanding balance on your loan's online account. For students who've been paying off loans for years, it's one of the best sights you'll ever see. You should receive communication from your loan servicer that your loan has been completely paid off. Keep records of any correspondence for yourself and to use around tax time.

Your credit score might slip slightly

Having your loan debt paid in full is a good thing, but it could cause your credit score to drop, at least temporarily. That's because of something called credit mix. Your credit mix is the different credit account types you have. Credit mix accounts for 10% of your FICO credit score.

A varied credit mix can help your credit score, so having your student loan debt wiped out creates a less diverse credit mix. The good news is that your credit score will likely go back up within a couple of months.

Your DTI could improve

Debt-to-income ratio (DTI) is affected by your monthly debt obligations like credit card bills, your mortgage, and yes, your student loans.

When your loans are forgiven, your debt obligation total will decrease. You could see a dramatic drop depending on how much of your loan debt was forgiven. In turn, your DTI would improve significantly because you are carrying less debt in comparison to your gross monthly income.

Related: Why DTI Matters — Even for Doctor Mortgage Programs

Your payment history will remain

While your debt may disappear after receiving loan forgiveness, the payment history on your credit report won't. At least not right away. The information recorded on your credit report typically stays on the report for seven and ten years, depending on the type of information.

It would not be an issue if you make on-time loan payments. Having positive marks on your credit report can only help you. If you had late or missing payments, having them stay on your report could affect future credit decisions, such as buying a home or a new car. There's a chance negative marks or late payments get removed from your report after your debt is forgiven, but there's no guarantee.

You might have tax implications

Some forms of student loan forgiveness come with a tax liability for the borrower. Depending on the type of forgiveness received, you could end up paying taxes on the forgiven amount. The good news for current borrowers is that IDR forgiveness is tax-free through the end of 2025, thanks to the Biden Administration and changes to the American Rescue Plan passed in 2021. The legislation declared an income tax exclusion on all federal student loan debt forgiven or discharged by December 31, 2025.

Previously, your remaining debt was forgiven after 20 to 25 years of IDR payments but considered taxable income by the IRS. This could lead to a significant tax bomb in a couple of decades, although you'd have time to save up for it. There's no indication if tax-free forgiveness will continue beyond 2025, though. Depending on when you receive forgiveness, you could end up paying hefty income tax on your forgiven debt.

Depending on where you live, you could also end up paying state tax on your forgiven debt. Some states handle loan forgiveness differently. Check with a local tax professional to determine if your forgiven debt is tax-free in your state.

You could get a refund

The CARES Act legislation paused federal student loan payments for an extended time during the pandemic. If you made payments during that time, though. You could be eligible for a refund even if your loans are forgiven. Contact your loan servicer for more information if you made monthly loan payments during this time.

Next steps after student loan forgiveness

For many borrowers, paying off their student loans is their primary financial goal. Sometimes, loan repayment can cause you to defer other life goals, career goals, and financial goals until you've paid off your debt. Not only does forgiveness free up more money each month to put towards other debts or to save for other goals, but it can provide a sense of relief and security.

Consider setting new goals if your loans have been forgiven or will be soon. Perhaps it's providing yourself or your family with more security by investing in life insurance or disability insurance. Maybe having no more student loan debt frees you up to make that career change you've dreamed about. You could apply the freed-up funds towards a down payment on a new home. Take stock of your current financial situation and desired goals and go from there.