How Does Student Loan Forbearance Affect Your Credit Score?
- Under the CARES Act, student loan forbearance allows borrowers to stop making payments without harming their credit scores.
- This can help borrowers use their money to boost emergency savings or pay down other debts.
- It's a mistake to spend extra money on nonessentials when you have defered student debt.
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The CARES Act passed by Congress in March had an unexpected side effect: Student loan borrowers saw their credit score go up by an average of 9 points.
Student loan forbearance is one of the ways that the CARES Act helped ease financial strain for Americans during the pandemic financial crisis. All federal student loans were put into a deferred status through September 30 (which has now been extended until the end of the year).
The CARES Act also required that the deferred loans be reported to the credit bureaus as paid on time. This provided a credit score boost for those who had been behind on their student loan payments. However, the improved credit score will only last as long as the loan remains current. If borrowers aren’t able to resume paying their student loans after the deferment period ends on December 31, then their credit score will probably go back down.
It’s important to note that the CARES Act, and the extension that President Trump signed recently, only applies to federal student loans. If you have a private student loan and are unable to make your payments, contact your lender directly to ask for a student loan forbearance.
If you have a federal student loan that is deferred, you may be wondering if you should you keep making payments or find other uses for the money. And how can you make the most of a good credit score while you have it? Let’s explore your options.
If your income is limited
If you’re currently unemployed or your income is reduced, then the money you’re saving on student loan payments should probably go first to covering necessities like rent, food, and utilities. Put any money left over after necessities into a savings fund to pay for future basic needs until your income is restored.
If you have steady income
If you have enough income to cover all your basic needs and don’t have to make student loan payments at the moment, you may be able to use this time to strengthen your financial situation and get some debt paid off. Here are some ways you could use your student loan money during the student loan forbearance period:
1. Build a safety net
Even if you’re doing fine right now, keep in mind that we’re living in through the greatest economic recession since the Great Depression. So if you have the means to do so, the first priority should be saving enough money to cover 3-6 months of basic living expenses. There’s a certain peace of mind that comes from knowing you can weather a financial setback if needed, and it provides a solid foundation for future financial goals.
2. Pay off high-interest debt
If you already have a healthy emergency savings fund, then now may be a good time to consolidate or refinance other debt, like high-interest credit cards. Here are four ways you could temporarily divert your student loan payment toward knocking down other debt.
Balance transfer card
Since the pandemic started, lenders are handing out fewer balance transfer cards. But if you can get one, you could consolidate multiple credit cards onto a no-interest card and then funnel your student loan payments into paying it down while your student loan is in deferment. But before you do this, calculate the balance transfer fee—you might actually save more money using the debt avalanche method below. Finally, consider if it would be worthwhile to use a transfer card if you can only pay off a small amount of your credit card debt before you have to return to repaying student loans.
Debt avalanche method
If you have credit cards with high interest rates, reduce what you pay in interest each month by aggressively paying as much over your minimum payments as possible. Minimum payments typically only cover interest and a little bit of principal, so the more you can pay over, the more you’ll be paying on the debt and less on interest over time. During the forbearance period, take what you would have been paying on your student loan to pay down the credit card debt with the highest interest rate.
A personal loan can be used to consolidate all your high-interest credit card debt into one payment. This may make sense if the lender can offer you an interest rate significantly lower than your credit cards. The better your credit score, the more likely you are to get a good interest rate on a personal loan (though they do take other things into account, like your debt-to-income ratio.) But make sure you take the origination fee into account to see how much you’ll actually save.
If you have a hard time paying more than the minimum payments on your credit cards, then temporarily using your student loan payments to chip away at your debt may not help you much. In this scenario, debt settlement might be a better option for you, since it can significantly reduce the overall amount you owe. In debt settlement, you or a company you work with negotiates with your creditors to reduce the amount you owe so you can pay it off faster for less.
3. Make payments on your loan
If your safety net is in place and you don’t have other high-interest debt to pay down, then your best option may be to continue paying your student loan even while it’s in deferment. Even though you’re not required to make payments on your student loan, you can choose to, and the great thing about doing so is that your entire payment will go toward the principal of your loan, not interest. So if you keep making your regular payment while in deferment, all the money you normally would have paid on interest will go toward paying your loan down faster.
What not to do with your student loan payments
During the deferment period, avoid the temptation to spend your student loan payment money on non-essentials. It may be tempting to think of this as extra spending money, but keep in mind that just because you’re not paying on your student loan right now doesn’t mean that debt goes away. It’s still sitting there, and it will begin accruing interest again as soon as the deferment period ends. If you get used to using that money on other things, it may be harder to resume making your student loan payments when the deferment period ends.
What if your credit score still isn’t high enough?
If you’re fortunate enough to have a job and income, but can’t always make your debt payments, then your credit score may still be too low to get a consolidation loan or balance transfer card, even with the boost from a deferred student loan. To find out what other options you have to more affordably reduce your debt, talk to one of our Certified Debt Consultants. The consultation is free and you can easily get started online now.
Editor’s Note, December, 2020: The Department of Education announced on December 4th that student loan forgiveness for federal loans will be extended until January. 31st, 2021. More changes may be coming, so be sure to check with your lender for the latest information.
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