Does Student Loan Forgiveness Affect Your Credit?

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If you’re feeling strapped with your federal student loan repayments, you may consider enrolling in a student loan forgiveness program. When your federal loans are consolidated into the direct loan program, you can be eligible for forgiveness in certain cases, whether by repaying your loans consistently for 20 to 25 years, or by following a career path in public service. But if you do reach the point where the balance of your federal student loans are forgiven, what happens to your credit? Let’s find out the potential consequences.

Lower Debt Utilization

One major advantage of getting your student loans forgiven is that the loan balance is removed from your credit report. The amount of overall debt you carry directly affects your credit score. The more debt you have, the lower your credit score will be because you’re perceived as being more cash-strapped. So when your federal student loan balance is forgiven, you show that you have more financial flexibility, thus improving your credit score.

The one time this may not work in your favor, however, is if you carry a large amount of credit card debt as well. A student loan is considered an installment loan, which is looked upon as a better debt to have compared to a revolving line of credit like a charge card. A student loan represents a higher education and more earning potential, while credit card debt is viewed strictly as a burden. If you take away your student loan, which is an installment loan, your outstanding credit card debt could increase your revolving credit ratio. Talk to a credit repair expert to find out more about your personal situation and how loan forgiveness could affect it.

Payment History Remains

Even when your student loan balance is forgiven, your payment history from the last seven years remains on your credit report and impacts your score. Just because the loan is considered satisfied doesn’t mean that your payment history is suddenly erased. That makes it especially important to keep on track with your federal student loan payments. Otherwise, there’s little you can do but wait for the passage of time to help improve your credit payment history.

If necessary, see if you qualify for a federal income-based repayment (IBR) program. This can lower your monthly payment amount while still keeping you on track for loan forgiveness. You might not, however, end up with the cheapest loan in the long-term. IBR typically draws out your repayment term so you could pay more interest over time. But if you’re already working towards forgiveness after a certain period of time, there might not be much of a difference, especially when you’re only paying your loans based on a percentage of your monthly income.

With payment history consisting of the largest contributing factor to your credit score, it’s vital that you find a way to keep those payments on time, even if you’re close to reaching forgiveness. Plus, your loan forgiveness eligibility is typically determined by reaching a certain threshold of on-time payments. If you make your payment a month late, that doesn’t even count and you have to push back your forgiveness date.

Tax Burden May Increase

Another way student loan can impact your finances, including your credit score, is by increasing your tax liability. Some federal student loan forgiveness programs (though not all of them) count your forgiven amount as extra personal income. So imagine if you have a $25,000 loan balance when you reach forgiveness eligibility. That would add $25,000 to your personal income amount for the tax year, which could easily bump you into a higher tax bracket.

If this happens, you’ll be responsible for whatever tax bill you have. While that alone won’t affect your credit score, you can expect a big impact if you have to use your credit card or a personal loan to cover your tax bill. Worse yet, if you leave the bill unpaid you can get a tax lien or wage garnishment imposed. Both of these hurt your finances and show up on your credit report. Tread carefully when it comes time to execute the forgiven balance. The last thing you want to do is create a new financial burden when you’ve worked for years and years to give yourself some relief.

Can private student loans be forgiven?

Unfortunately, private student lenders typically don’t offer loan forgiveness. While you may be able to enroll in a specific repayment plan to help you meet your financial needs, you can’t expect to have any lump sum forgiven. Instead, it’s common to refinance private student loans to try and either qualify for a better rate or lower your payments by spreading them out over a longer term. The only way to qualify for true student loan forgiveness is if you have a direct federal loan.

But before you jump into a forgiveness program for your federal student loans, make sure you’re prepared for the potential financial impact. Your student loan forgiveness can help your credit score in some ways, but hurt it in others. Be prepared in advance so you know what to expect,and if you need help fixing your credit score, let know.

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