Biden’s $10,000 student debt forgiveness is a game-changer for borrowers’ wallets – but will it help their credit scores?
By Andrew Keshner
The financial implications of the Biden administration’s loan cancellation plan go beyond debt balances
In an era of record borrowing costs and rising prices, people need all the help they can get from their credit scores.
Some people could get a surprise boost — if they have student loans set to be forgiven under President Joe Biden’s executive order wiping out federal student loan debts up to $10,000 and, in some cases , $20,000
TransUnion – one of the three major credit bureaus in the country alongside Experian and Equifax (EFX) – recently ran a simulation exploring the potential credit rating implications of the executive order canceling Biden’s student debt.
Here’s the result: TransUnion ran its simulation on five scores – from a “subprime” range of 300-600 to a “super prime” range of 781-850. Most people stayed in the same credit score range they already occupied even after subtracting the $10,000 debt.
However, TransUnion found that on average 88% of consumers remained in the same of five “credit risk levels” when researchers looked at a person’s credit score at a single “static” point in time. In a “trendy” approach that can be summed up in numbers over several months, 79% stayed where they were.
Canceling $10,000 of hypothetical student debt pushed 9% of those consumers in the “static” model to a higher score range, and did the same for 20% in the “trend” approach, showed the research.
Lenders may apply various score ranges to make lending decisions, but higher score ranges generally lead to more favorable borrowing terms.
In contrast, nudges to a lower range occurred for 1% or 3% of borrowers, depending on the scoring method. And a notable share of those people had student loan balances below $10,000.
“For the majority of consumers, you don’t see a change in the level of credit risk,” said Jessica Harmon, senior director of TransUnion’s market strategy and consumer lending unit. “That being said, some consumers saw changes in risk levels. It was a two-way street,” Harmon said.
She added, “We saw a more negative change for people with balances below $10,000.”
At the end of last year, there were more than 43 million student borrowers with a cumulative balance of about $1.6 trillion, according to the Federal Reserve Bank of New York. Nearly a third of borrowers had debts of up to $10,000, according to data from the New York Fed.
A New York Fed study, released months before Biden’s announcement, estimated that more than half of the share of canceled debt would go to borrowers with scores below 660, suggesting there is plenty of room for upside. This was found to be true with both a $75,000 income cap and no income cap, the New York Fed researchers noted.
So why would someone who reduced their debt have an impact on their score? A person’s “credit makeup” — showing how they handle different types of debt — could be a factor, the researchers noted.
“Like that [forgiven student] loan would be closed, or multiple loans would be closed, that the credit mix is less diversified, which could reduce the credit score,” said Kendall Meyer, principal consultant, data science and analytics, at TransUnion.
Averages are weighted to incorporate multiple scenarios, such as consumers with multiple loans, one loan, balances below and above $10,000. The share of consumers with balances below $10,000 who are pushed to a lower range is “significantly higher” than the average 1% to 3%, a TransUnion spokesperson said.
When it comes to underwriting, most lenders still review credit scores based on “static” ratings, he noted.
Suppose borrowers experience point swings up or down, but remain within their credit score range after loan cancellation. How will it affect them if they need a loan, credit card, or other transaction that requires a credit check? It’s hard to say for sure because there are many variables, including the possibility of lenders using their own score ranges, the TransUnion spokesperson noted.
If nothing else, the study is a good reminder to keep tabs on your credit score. Last week, TransUnion, Equifax and Experian announced they were extending free weekly credit reports through the end of 2023.
Legal challenges to debt forgiveness
Biden’s order will end student debt for about 20 million people, the president said. Meanwhile, the stage prepares for a courtroom showdown over the loan cancellation plan itself.
Proponents say canceling student loans could help borrowers pay off other debt and build wealth. despite the skyrocketing costs of higher education But opponents say it is an unfair boon that will further fuel inflation.
The Pacific Legal Foundation has filed a lawsuit in the Southern District of Indiana, alleging that the Biden administration is making an “end run around Congress.”
The plaintiff, Frank Garrison, is a firm attorney and a Pell Grant recipient who is on track to receive up to $20,000 in debt forgiveness through Biden’s order. But the cancellation could also result in an Indiana state income tax bill that Garrison had no intention of paying.
Although student loan debt forgiveness is exempt from federal income tax, tax laws vary from state to state.
White House press secretary Karine Jean-Pierre on Tuesday defended the loan cancellation order, saying borrowers don’t have to forgive and can always opt out of the plan.
But Republican critics could sue, and if they do, an expert said the administration’s lawyers could face serious legal issues blocking or preventing implementation.
On Tuesday, a libertarian-leaning public interest law firm filed a federal lawsuit in an attempt to block debt cancellation. The case alleges that the administration exceeded its authority.
TransUnion (TRU) has no policy position on whether or not to cancel student debt, and this is obviously just a simulation, and the analysis was based on four million credit files out of the 200 million credits held by the three main offices.
But the analysis highlights how Biden’s controversial order — applying to borrowers with annual incomes of up to $125,000 — may have implications beyond a person’s student debt balance.
Measuring potential consequences is an ongoing process. The loan forgiveness will cost the federal government about $400 billion, the nonpartisan Congressional Budget Office said Monday.
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