A new study from the Federal Reserve Bank of New York said the moratorium on federal student loan payments has enormously impacted borrower's finances and credit scores.
The study, conducted by researchers from the New York Fed's Center for Microeconomic Data, said that 79%, or 30 million federal borrowers, saw improvements to their credit scores over the course of the payment pause. And 21.9%, or 8 million borrowers, increased their scores enough to migrate to a higher credit score group.
These borrowers, some of whom had defaulted or were delinquent on loan payments before the pandemic, were able to rehabilitate their loans during the forbearance period without having to make monthly payments, the study said.
President Joe Biden’s student debt forgiveness plan could also help improve borrowers' finances and credit scores. Earlier this week, Biden announced that the student loan payment pause would be extended until Dec. 31. He also outlined a plan to cancel $20,000 in student loans per eligible borrower if they went to college on Pell Grants and $10,000 in student loan debt per eligible borrower for those who didn’t.
Following Biden's announcement, the Department of Education said that nearly 8 million borrowers may be eligible to have their debt forgiven automatically because of already-available relevant income data. Biden also said during a news conference that 95% of federal borrowers, or about 43 million people, would benefit from the plan. Of those, he said that more than 60% are Pell Grant recipients.
Only borrowers with federal student loans are eligible for forgiveness under the Biden administration’s plan. But if you have private student loans, you could consider refinancing to help you save on your monthly payments. You can visit Credible to find your personalize rate without affecting your credit score.
All federal student loan borrowers to get a 'fresh start'
Federal student loan borrowers with remaining balances will have to start repayment again on Jan. 1, 2023. All federal borrowers – regardless of whether they were current on loan payments before the pause, had a loan in default or hadn’t yet started paying off their loan – will be given a fresh start next year and enter repayment in good standing, according to the Federal Student Aid (FSA) office.
The Fresh Start program essentially gives borrowers in default an opportunity to rehabilitate their loans and change their credit history to show the loans as "current" rather than "in collections." They would be given one year, after the end of the pause, to arrange for payment of these debts, the FSA said. The program would apply to 7.5 million student loan borrowers that were delinquent or in default prior to the pandemic.
What’s more, the Department of Education would use a loan’s original date of delinquency if borrowers became delinquent or went into default again after the Fresh Start opportunity. This means the seven-year timeline would not be reset for a borrower’s credit report.
If you have private student loans and don’t qualify for forgiveness, you could consider refinancing at a lower interest rate to reduce your monthly payments. Visit Credible to find your personalized interest rate without affecting your credit score.
How to prepare for payments to resume
Given the payment pause extension, it could be a good time for borrowers to get on a budget and make a plan to pay off student loans.
If your loan was in default prior to the pandemic, you can reach out to your student loan servicer and find out what you need to do to bring it back into good status. You could also consider switching to an income-driven repayment plan to lower your monthly payments.
Borrowers who work in public service careers – including teachers, government workers, first responders and firefighters – could also check their eligibility for the Public Service Loan Forgiveness (PSLF) program.
Borrowers could also opt to leverage their improved credit score and refinance their loans, since higher credit scores generally offer better loan terms, according to Jason Mikula, managing director at Fintech Business Weekly.
"For those that have seen their credit scores increase, one option that may be available to better manage their student debt is to refinance," Mikula said. "Depending on the types of loans they have and the rates, refinancing their student loans may allow them to lock in a lower rate and/or lower their monthly payments."
Keep in mind that refinancing federal student loans into private loans means losing out on many federal student loan benefits, including income-driven repayment plans, deferment, forbearance, and student loan forgiveness. To learn more about your student loan options, you can speak to an expert at Credible and get all your questions answered.
How does debt forgiveness impact credit scores?
The millions of Americans who are eligible for the Biden administration’s student loan forgiveness plan can take steps to make the most of how it impacts their personal finance and credit scores.
"The student loan forgiveness won’t give borrowers access to more wealth but what it will do is save them the negative effects of getting behind on debt," Richard Barrington, a financial analyst for Credit Sesame, said. "This includes compounding interest charges, late penalties, and damage to their credit scores."
Barrington said that people who have had their debt forgiven may want to hold off on applying for new credit or a loan right away. That's because anytime a credit card or loan of any kind is closed, it can result in a small ding on the borrower's credit score, he said.
Barrington also said that this student loan debt relief creates an ideal opportunity for people to pay down their high-interest credit card debt.
"This will not only save you even more money by avoiding compounding interest payments, but it will improve your credit score along the way - paving the way for lower-interest loans on things like cars and homes in the future," he said.
If you have private student loans, you will not qualify for federal student debt relief, including cancelation. But you can potentially reduce your monthly payments by refinancing. Visit Credible to get prequalified for a student loan refinance in minutes, without affecting your credit score.
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