Biden's student loan forgiveness may cause plummet in credit scores for some borrowers

Biden's sweeping plan to wipe out $20,000 in student debt for tens of millions of Americans may be undesirable, but for some it is expected to be effective, experts say.

"For many borrowers, this leads to lower credit scores," says higher education expert Mark Kantrowitz.

Here's why: During the three-year moratorium on federal student loans, Kantrowitz said, borrowers report to credit bureaus as they do today. (Currently, payments are scheduled to start again in September.)

Paying on time will help people's credit scores improve.

"Payment history is the most important factor in the credit scoring formula," said Ted Rothman, senior analyst at Bankrate.com.

If the Supreme Court rules that the bailout program is legal and enforceable, millions of borrowers' student debts will be full and on file. The good news is, Kantrowitz said.

Of course, a temporary decrease in credit rating for someone who owes thousands of dollars will not be a problem. In addition, those who have a balance after the cancellation will not see their balance decreases if they pay their bills on time.

Rothman said that while tolerance can lower your credit score, reducing your debt will ultimately help improve your rating. That's because reducing debt increases what you call the debt-to-income ratio, he said.

Lenders consider this amount when deciding how much to borrow. Some people use a rule called the 28/36 rule, which says that no more than 28% of total monthly income should go to housing expenses and no more than 36% to total expenses. (Some lenders offer more.)

"Overall, I think student loan forgiveness is a significant benefit to a person's overall financial condition, even as their credit score declines over time," Rothman said.

Focus on Paying Off Other Debts

While the borrower's status is low, another benefit of forgiving student loans is the opportunity to pay off other debts faster, Rothman said.

While average credit card interest rates are at historic highs, "it's important to pay off credit card debt first," he said.

Ross Mann added, "The extra money you can spend on these expenses can also improve your credit score."

If the Biden administration can forgive student loans, Rothman said he expects the program to show up on his credit report in a month or two.

It is recommended that you regularly check your free report on AnnualCreditReport.com to ensure that the three credit rating agencies (Experian, Equifax and TransUnion) are reporting the correct information.

Kantrowitz said that if Biden's plan fails in the Supreme Court, re-granting student loans will not affect borrowers as long as their credit scores are kept fair.