Biden student loan pause could give 7 million borrowers a higher credit score

Student Loan: The more than 7 mn borrowers with defaulted federal loans will get the default removed from their credit report and be given a second chance to get back on track making payments, the Education Department said
Student Loan: The more than 7 mn borrowers with defaulted federal loans will get the default removed from their credit report and be given a second chance to get back on track making payments, the Education Department said

Summary

Borrowers who defaulted on their student loans will get a second chance

President Biden didn’t forgive any student-loan debt when he extended a pandemic pause on payments through Aug. 31, but he did forgive the debtors.

The more than seven million borrowers with defaulted federal loans will get the default removed from their credit report and be given a second chance to get back on track making payments, the Education Department said.

The change will improve the financial prospects of these borrowers, as a default significantly hurts people’s chances of getting auto loans, mortgages and credit cards. It may also limit one’s ability to get a job, rent an apartment or enlist in the U.S. Armed Forces.

People go into default after 270 to 360 days if they fail to make required payments on the federal loans, don’t receive a deferment or forbearance, or don’t obtain an income-driven repayment plan.

A default can cause a 100- to 200-point drop in your credit score, said Mark Kantrowitz, an author and entrepreneur who has built several businesses around explaining financial aid and student debt. Borrowers with a default often end up in the subprime range, he said.

“Having the default cleared gives borrowers the opportunity for a clean slate," said Mr. Kantrowitz.

This reprieve will raise the credit scores of defaulted borrowers when the plan takes effect, probably within 30 days of the Education Department reporting the change to the major credit bureaus such as Experian PLC, Equifax Inc. and TransUnion, Mr. Kantrowitz said. How much of people’s credit score will rise depends largely on their individual circumstances.

Someone with an otherwise excellent history could take a large hit from one negative event such as a student loan default, said Ted Rossman, senior industry analyst at Bankrate. Yet, if borrowers have defaulted on their student loan but also their credit card, mortgage and auto loan, the removal of the default may not be as significant, he said.

Getting a default scrubbed is an opportunity for many borrowers to rebuild their credit. People should take advantage of an income-driven repayment plan if they are eligible, Mr. Kantrowitz said. Defaulted borrowers normally don’t have access to such programs.

In a statement last week, U.S. Secretary of Education Miguel Cardona said the extension will “ensure that all borrowers have access to repayment plans that meet their financial situations and needs."

If your total student loan debt exceeds your annual income, you should be able to qualify for a reduced payment under an income-driven repayment plan, said Mr. Kantrowitz.

Your monthly payment under an income-driven plan is a percentage of your discretionary income, according to the Education Department. Depending on your income and family size, you may have no monthly payment at all under these plans. If your income is less than 150% of the poverty line, your monthly student loan payment will be zero.

Eligibility for income-driven repayment is limited mostly to federal student loan borrowers.

Federal Parent Plus loans aren’t directly eligible for income-driven repayment. Your total balance can increase with this plan and you may have to pay taxes on your forgiven balance, Mr. Kantrowitz said. You’ll need to recertify for the program every year.

The income-driven payment plan is preferable to the costs borrowers face in default, which may include wage garnishment, offset of income-tax refunds and Social Security benefit payments.

Borrowers who default typically do so after dropping out of college, and are left with debt, but no degree to help them repay it.

The clean slate alone likely won’t be enough to help many borrowers who are struggling to get by, Mr. Kantrowitz said. Without additional help, some may end up defaulting again because they’ll still be in a difficult financial situation.

“The Education Department will need to target these at-risk borrowers for special counseling to help prevent them from defaulting again," he said.

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