The freeze on federal student loan payments in the U.S. during the COVID-19 pandemic has offered millions of Americans a vital financial break. But borrowers could soon be on the hook again, with the moratorium in place expiry at the end of the month.
More than 79 percent of those with student debt, a total of 30 million people, saw their credit scores improve during the pandemic, according to a report from the Federal Reserve Bank of New York this week. Nearly 8 million borrowers raised their scores enough to jump to a higher credit tier.
“The pandemic repayment pause dramatically reduced delinquencies and defaults on student loans, so we’ve seen increases in credit scores across the distribution of student debtors,” said Marshall Steinbaum, senior researcher at higher education finance at the Jain Family Institute. “Credit scores for student debtors have increased overall, but they have increased more for less affluent student debtors.”
The Biden administration has yet to make a final decision on whether to do so cancel student debt for nearly 40 million Americans. Meanwhile, missing payments or defaulting on your student loan can have far-reaching financial consequences.
“Overall, student debt is weighing on the financial well-being of many households and inhibiting creditworthiness and all that comes with it,” Steinbaum added.
How your credit score is determined
Your credit score, which tells a lender how likely you are to make or miss a debt payment, is largely calculated based on your payment history. Other factors, such as how much you owe on car loans and credit cards and the length of your credit history, also affect your score. The types of accounts you have and your recent credit activity make up the rest of your score.
Generally speaking, this is how your credit score is calculated:
- Payment history (35%)
- Amounts due (30%)
- Length of credit history (15%)
- Types of credit accounts (10%)
- New credit (10%)
So what happens if your federal student loan grace period ends and you can’t make the payments? The harsh reality is that missed payments will affect your credit score. What is less straightforward is how much.
“That’s the impossible question. There is no fixed number of points for any event on a credit report,” said John Ulzheimer, a credit expert who has worked at Equifax and FICO, two of the biggest credit scorers.
If your credit history is impeccable, just one late payment can lower your score dramatically.
“If you have a great credit report and suddenly start missing payments, the impact will be more dramatic than if you already have bad credit and start missing student loan payments,” Ulzheimer said.
Having debt is harmless to your creditworthiness as long as you make your payments on time and default on the loan.
“It’s really a problem of defaults and missed payments when you start having a lot of problems,” he said.
Rising interest rates on federal student loans make it more expensive to borrow money for college;
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Credit scores typically range from 300 to 850, with scores of 670 or higher considered good to excellent. The average FICO score in the US was 714 in 2021, according to Experian.
Even a single late payment can seriously tarnish an otherwise strong credit score, dropping it by as much as 100 points, according to Ted Rossman, credit expert at Creditcards.com. On the other hand, if your payment history has already been inconsistent, a missed payment or two will have less of an impact.
“If you already have a ton of late payments and you have a lot of debt, an extra late payment won’t hurt you as much as it would for someone with a perfect credit score,” Rossman said.
Unsurprisingly, defaulting on a student loan will usually cause more damage.
“It could easily cut 150 or more points off your score. You want to avoid getting to that point,” he said.
A bad credit score can make it difficult to rent or buy a home, buy or lease a car, get a cell phone plan, or even sign up for utilities like electricity and gas. Some employers even check candidates’ credit histories.
“Your credit score is one of the most important numbers in your financial life,” Rossman said. “It will go a long way to determine whether or not you are approved for loans and lines of credit.
The worst you can do is nothing
Ignoring past due student loan payments is never wise.
“If you’re having problems outside of the current tolerance, you definitely want to talk,” Rossman said. “There are options available; your lender can work with you. The worst thing you can do is nothing.”
For example, you can ask to be on an income-based repayment plan or consolidate your loans into a private plan.
In an income-based repayment plan, your monthly payment is set at a rate that is affordable to you based on your income, usually between 10% and 15% of your discretionary income.
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