Defaulting on a student loan can cause severe damage to your credit score, but taking the necessary steps to repair your credit can help you fix it. Read along further to learn more about those steps.
What happens when you default on a student loan, and how does it impact your credit?
- First, credit rating agencies count your missed student loan payments the same as missed payments on your other loans and credit cards.
- One missed payment can drop your credit score by about 100 points.
- Going forward, with every payment you miss, your credit score suffers.
- A record of your missed student loan payments will continue reflecting on your credit report for up to seven years.
- Taking out loans in the future may get challenging.
In all honesty, the road ahead may not be easy, and the process may be a lengthy one. So carefully look at this list of strategies that can help you repair your credit even after defaulting on a student loan.
Five steps to repairing your credit after defaulting on a student loan
1. Get out of default first.
The first and most crucial step to repairing your credit is to get out of the student loan default because when you default, it can get sent to collections. If this happens, you will get notified via mail.
You must call the number on the letter and learn about your options if you receive such a notice.
You’ll typically have three possibilities in this scenario:
a) Pay off your loan
It’s simple, pay off your loan in full and get out of your student loan default. Although, it’s easier said than done since the average student loan balance is in the tens of thousands of dollars.
If you have a family member who can help you by loaning money at a lower interest rate, this could be a reasonable option.
You could also apply for a loan to pay off your student debt with a consignor and obtain better APR rates and terms.
b) Rehabilitate your loan
Work with your loan servicer or collections agency on a plan to make a series of affordable monthly payments. Explain that you want to get out of default, but you can pay only a certain amount each month.
You can significantly benefit from loan rehabilitation and will most likely be able to remove the default status from your credit report as long as you make monthly payments on time for that given period.
c) Consolidate your loan
Consolidating several federal student loans into one will count as a payment and bring you out of default. You have two choices to qualify for a consolidation (note, this is for federal rather than private student loans). Make three on-time payments before applying for the federal Direct Consolidation Loan.
Or, you can apply for an income-driven repayment loan, which will set your monthly payments on the new loan at a portion of your disposable income, making repayment affordable.
2. Pay off your other debts.
Another way to rebuild your credit after a student loan default is to pay down your other debts, such as credit cards.
30% of your credit score comes down to your credit utilization rate. So when your credit cards are close to maxing out, they hurt your score, but if you pay down your balances and lower your utilization rate, your credit score goes up.
Paying off other debts also helps your credit situation. When you apply for a new car loan or a mortgage, lenders look at how much you already owe in debt. You can look like a risky applicant with a high amount of debt. On the contrary, you have a better chance of qualifying despite not having the perfect credit score if you’re relatively debt-free.
3. Pay all your bills on time every time.
You should look at your finances if you struggle to pay your phone bills or any other bills on time, and doing so will help ensure you don’t miss them in the future. Paying your bills on time is a lot more important than you think. Your payment history accounts for 35% of your credit score, making it the most significant factor in your score.
Following a budget is a great way to make timely payments and improve your credit score. Remember, skipping payments on your bills can stay on your credit report for seven years. So be sure to make your payments on time. Consider using autopay options to avoid this situation.
4. Take out a secured credit card.
Getting a secured credit card can help you to build your credit. These work like regular credit cards, but you need to make a deposit with the company that backs up your line of credit.
For instance, when you deposit $1000, you can spend up to $1000 on your card. You’re supposed to pay off your purchases every month like any other credit card, and if you don’t, you’ll eventually forfeit the deposit.
Making monthly payments on a secured credit card helps you build your credit just like any other credit card.
Sadly, these accounts charge a high fee and don’t offer any bonuses. Yet, they are better than nothing when you’re trying to build your credit after defaulting on a student loan.
5. Take out a credit-building loan.
Credit-building loans are the type of a loan meant to help borrowers build their credit. They are nothing like a personal loan where you receive a lump sum and pay it back with interest over an established period.
When you take out a credit-building loan, you can’t access the amount you’ve borrowed until you pay off the loan.
It is easier to get a credit-building loan over a traditional loan with bad credit as the lender takes less risk by holding the money you borrow. While you’re repaying the loan, the lender reports your payments to the credit bureaus, ultimately improving your credit score.
It’s a fact that repairing your credit after defaulting on a student loan or any type of loan is not an easy or quick process. You need to consistently pay all your bills and dues on time, maintain low credit card balances, and occasionally open new lines of credit (without maxing them out) to keep pushing your credit score higher.
You should continue these best practices, and soon you’ll be on your way to seeing improvements in your credit. Taking the help of professionals can make it easier to combat the situation.
Schedule a free consultation with Cool Credit today, where a team of professionals will review your score and recommend the best solution most suited to your budget.