Friday, March 27, 2020

$2 Trillion Stimulus Package and Delayed Student Loan Payments

In the midst of the coronavirus outbreak, millions of Americans are also worrying about how they’ll pay the bills. This week, the federal government is taking steps to relieve some of the pressure with a sweeping stimulus package that offers some relief with expanded unemployment benefits, stimulus checks and an opportunity to pause federal student loan payments.

While the House of Representatives still needs to vote on the bill, if it passes, federal student loan borrowers could get a break from their monthly payments through Sept. 30, 2020. Any interest accrued during the suspension would also be waived.

But what does all this mean for your credit score? We have good news and bad news.

Below, is some information about what postponing student loan payments could mean for your credit score.

The difference between deferment and forbearance.

Deferment and forbearance are two ways to temporarily suspend your student loan payments. Both options protect your account from falling into delinquency, so if you anticipate trouble making your minimum payments you should inquire about both. If you don’t take these steps, you could lose your chance to qualify for income-based repayment plans and other forms of assistance down the line.

Under normal circumstances, these two federal loan postponement options look like this:

Deferment: You might qualify for this if you meet certain requirements, such as you went back to school, joined the PeaceCorps or lost full-time work. While a loan is in deferment, you aren’t required to make monthly payments but the interest on your loan will continue to accrue (with the exception of some subsidized loans). The amount of time you can defer a loan depends on the type of deferment you apply for, but borrowers who are in deferment because of financial hardship or unemployment can only defer federal student loans for a maximum of three years.

Forbearance: This is a second option to postpone your student loan payments, and it’s reserved for when you don’t qualify for deferment. Borrowers must be approved for a forbearance by their lender or servicer, and they typically limit your time in forbearance to 12 months. While a loan is in forbearance, you aren’t required to make monthly payments but the interest on your loan will continue to accrue (regardless of the loan type). Though you can request a forbearance on your loan as many times as you want, it’s not recommended to do so often. Lenders and servicers may limit how many times you are approved.

How do student loan deferment and forbearance affect your credit score?

Neither deferment nor forbearance on your student loan has a direct impact on your credit score. But putting off your payments increases the chances that you’ll eventually miss one and ding your score by mistake. If the coronavirus stimulus package is passed and borrowers receive six months of no payments, it could be easy to forget once your payments resume.

Borrowers should also take into consideration that if they were late or overdue on their student loan payments prior to them going into deferment or forbearance, this will still result in a negative entry on their credit reports.

How long does student loan debt stay on your credit report?

It depends. If you make all of your payments on time, student loan debt does not necessarily cause harm to your credit score.

But if you end up falling behind on payments or defaulting on your student loan, the negative account information will likely appear on your credit file for seven years from the original date that the account was first reported as past due.

If you can currently afford to make your monthly student loan payments, it may be a better idea not to prolong your debt by taking advantage of this potential six-month postponement period. That way, you remain on top of your payments and lower your risk of falling into delinquency. 

How can student loan debt on your credit report affect your credit score?

Student loans are considered installment loans, which impact your credit score differently than credit card debt does. Sometimes, carrying a student loan balance can actually help your “credit mix” by adding variety to the kind of loan products you have. But the small positive effect it may have on your credit score is not in itself worth delaying your loan payments.

The biggest key factor, making up about 35% of your score, is on-time payments. This applies to all revolving and non-revolving lines of credit, including your student loans. No matter the size of your loan debt, if you’re having trouble making your student loan payments each month, you’ll see this reflected in your credit score.  Any delinquent account that appears on your credit report can have a noticeable and negative impact on your score.

Last, having high student loan payments each month can make it harder to pay off your credit card balance. If you carry a balance from month to month, it will increase your credit utilization rate, the second-largest factor in calculating your credit score.

Which to pay off first: Student loan debt or credit card debt?

Paying off student loan debt and credit card debt should both be priorities, but there are options available to help you decide how to do it.

There are several affordable repayment options for federal student loans, which makes it helpful in situations where payments have to be prioritized based on most urgent needs.

I recommends finding an affordable repayment option through your federal student loan servicer, or perhaps refinancing if your loans are private. Then, work with a nonprofit credit counselor to keep your credit cards on track.  That way it’s not a choice of one over the other.

But you should be aware that paying down credit card debt first may help your budget since credit cards typically have higher interest rates than student loans. Paying down credit card debt will also lower your credit utilization rate, which boosts your credit score.

If you choose to prioritize paying your student loans first, you can transfer an existing credit card balance to a 0% APR card to save on interest.  The best balance transfer cards are usually reserved for those with good or excellent credit, but there are options available for fair credit as well.

What to do if your student loans are postponed.

Before you assume that your loans will automatically be granted deferment or forbearance because of coronavirus, carefully read over the stimulus bill when it passes, then check with your servicer to see what the new policies are.

Several servicers  provide that students have to actually request the forbearance rather than just assume they’ve been placed in a forbearance program.

But every servicer differs. For example, the federal student loan servicer Great Lakes announced that it will automatically grant a no-interest forbearance period for borrowers, but only those who are (or become) 30 days behind on their payments. In this case, you would risk falling behind on your payments and defaulting before you could qualify for assistance, and it may not be worth the potential damage to your credit score.

Bottom line: It’s important to determine what kind of assistance will apply to your specific situation and ask detailed questions if necessary.

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