By Andrew Keshner
At a time of record-high borrowing costs and rising prices, people need all the help they can get from their credit scores.
Some people might get a surprise boost — if they have student loans poised for forgiveness under President Joe Biden’s executive order wiping away federal student-loan debts up to $10,000 and, in some cases, $20,000.
TransUnion — one of the country’s three major credit reporting agencies alongside Experian /zigman2/quotes/204348666/composite EXPGF -1.11% and Equifax /zigman2/quotes/208789454/composite EFX +3.85% — recently ran a simulation digging into the potential credit-score implications of Biden’s student-debt cancelling executive order.
Here’s the upshot: TransUnion ran its simulation over 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 concluded that an average 88% of consumers remained in the same of five “credit risk tiers” when the researchers looked at a person’s credit score at a “static,” single moment in time. In a “trended” approach that wraps into numbers over several months, 79% stayed where they were.
Forgiving $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 “trended” approach, the research showed.
Lenders can apply various score ranges to make lending decisions, but higher score ranges typically lead to more favorable borrowing terms.
On the other hand, nudges to a lower range occurred for either 1% or 3% of borrowers, depending on the scoring method. And a noticeable share of those people had student loan balances under $10,000.
“For the majority of consumers, you don’t see a shift in credit-risk tier,” said Jessica Harmon, senior director in TransUnion’s Market Strategy-Consumer Lending Unit.“That being said, there were some consumers where we did see shifts in risk tiers. That went in both directions,” Harmon said.
She added, “We did see more of a negative shift for individuals who had balances that were less than $10,000.”
By the end of last year, there were more than 43 million student-loan borrowers holding a cumulative balance of approximately $1.6 trillion, according to the Federal Reserve Bank of New York . Almost one-third of borrowers had debts of up to $10,000, New York Fed data showed.
A New York Fed study, released months before Biden’s announcement, estimated that more than half the share of forgiven debt would go to borrowers with scores under 660, suggesting that there is ample room for upside. That held true with both a $75,000 income cap and no income cap, New York Fed researchers noted .
So why would a person who has lightened their debt load get a ding to their score? A person’s “credit mix” — showing how they manage different types of debts — could be one factor, researchers noted.
“As that [forgiven student] loan would close, or multiple loans would close, that credit mix is less diverse, which is potentially lowering the credit score,” said Kendall Meyer, senior consultant, data science and analytics, at TransUnion.
The averages are weighted to incorporate multiple scenarios, like 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 1%-3% average, a TransUnion spokesman said.
When it comes to underwriting, most lenders still review credit scores based on “static” scores, he noted.
Suppose borrowers have point swings up or down, but stay in their credit score range after the loan forgiveness. How will that affect them if they need a loan, a credit card or another transaction requiring a credit check? It’s difficult to say for sure because there are many variables, including the possibility that lenders are using their own score ranges, the TransUnion spokesman noted.
If nothing else, the study is a good reminder to keep an eye on your credit score. Last week, TransUnion, Equifax and Experian said they were extending free weekly credit reports through the end of 2023.
Legal challenges to debt forgiveness
Biden’s order will end student debts for an estimated 20 million people, the president said. Meanwhile, the stage is getting set for a courtroom showdown over the loan forgiveness plan itself.
Supporters say student-loan forgiveness could help borrowers pay down other debts and build wealth. despite skyrocketing higher-education costs . But opponents say it’s an unfair windfall that will further fuel inflation.
The Pacific Legal Foundation filed a lawsuit in Indiana’s Southern District, alleging the Biden administration is making an “end-run around Congress.”
The plaintiff, Frank Garrison, is a lawyer at the firm and a Pell Grant recipient who’s in line to receive up to $20,000 in debt cancellation through Biden’s order. But the cancellation could also result in an Indiana state income-tax bill that Garrison wasn’t planning on paying.
Though student-loan debt cancellation is exempt from federal income taxes, the tax laws vary from state to state.
White House press secretary Karine Jean-Pierre defended the loan cancellation order on Tuesday, saying borrowers aren’t getting forced into forgiveness and can always opt out of the plan.
On Tuesday, a libertarian-leaning public-interest law firm filed a federal lawsuit trying to block debt cancellation. The case alleges the administration overstepped its authority.
TransUnion /zigman2/quotes/209192458/composite TRU +3.51% has no political stance on whether or not to cancel student debt, and this is obviously just one simulation, and the analysis was based off four million credit files out of the 200 million credit held by the three major bureaus.
But the analysis does underscore how Biden’s controversial order — applying to borrowers with an annual income of up to $125,000 — may have implications beyond a person’s student-debt balance.
Measuring the potential consequences is an ongoing process. Loan forgiveness will cost the federal government an estimated $400 billion, the non-partisan Congressional Budget Office said on Monday.