Paying off student loan debt isn't always easy; and if you fall behind on payments, it's possible that you could end up in default status.
For federal student loans, you're typically considered to be in default on your loans once 270 days have passed with no payment. With private student loans, it's up to individual lenders to determine when you're in default after missing payments.
At any rate, the end result of defaulting on student loans is the same when it comes to your credit history. When you're no longer in good standing with your loan servicers because of late or missed payments, there can be a negative impact on your credit score.
The good news, however, is that it's possible to rebuild bad credit even if you've defaulted on student loan debt. These tips can help you begin the process of creating a positive credit history moving forward.
Start By Getting Your Loans Current
The first step in repairing bad credit when your loans are in default status is bringing those accounts current. How you do this depends on whether you have federal student loans or private student loans.
How to bring federal student loans current
With federal student loans, you have one of three options. You can:
- Rehabilitate your loans
- Consolidate your loans
- Pay your loans in full
Paying in full likely isn't an option if you've defaulted because of financial hardship or your loan payments simply weren't affordable enough for your budget. But you could still rehabilitate your loans or consolidate them to get them out of default and back on the right track.
Rehabilitating federal student loans means that you agree to make nine monthly on-time payments to your loan servicer over a period of ten consecutive months. Your loan servicer will determine the monthly payment amount based on your monthly discretionary income. According to the Department of Education, it's possible that your payment could be as little as $5 per month.
Once you make those nine timely payments, your loans come out of default. This won't erase any late payments already reported to the credit bureaus, but the default can be removed from your credit history. That could help to improve your credit score slightly.
If you choose to consolidate defaulted federal student loans into a new Direct Consolidation Loan, you either have to agree to repay the loan using an income-driven repayment plan or make three consecutive on-time payments toward the defaulted loan before consolidating. Unlike loan rehabilitation, getting a consolidation loan won't remove the record of default from your credit history. For that reason, it may be worth attempting to rehabilitate your loans first before choosing loan consolidation.
How to bring private student loans current
With private student loans, your options may be more limited since they don't follow the same guidelines as federal student loans.
If your lender doesn't offer any type of loan restructuring for defaulted loans, then you may need to consider refinancing instead.
Refinancing means taking out a new loan to pay off your existing loans. If you have bad credit or limited credit history, you may require a cosigner to get approved for a refinance loan. But refinancing could lower your interest rate and make your monthly payments more affordable.
Commit to Making Timely Payments
Payment history accounts for the largest share of your credit score calculations; so if you have a history of late or missed payments, then paying on time going forward is important for recovering from student loan default.
If you have federal student loans, opting for an income-driven repayment plan can help make monthly payments more comfortable for your budget. Income-driven repayment plans base your monthly payment on your discretionary income and household size.
Currently, the Department of Education offers these options for income-driven repayment:
- Revised Pay As You Earn Repayment Plan (REPAYE Plan)
- Pay As You Earn Repayment Plan (PAYE Plan)
- Income-Based Repayment Plan (IBR Plan)
- Income-Contingent Repayment Plan (ICR Plan)
With REPAYE and PAYE, your payments are generally capped at 10% of your discretionary income, with either one giving you 20 years to repay undergraduate loans. If you have graduate school loans, you can extend loan repayment up to 25 years using a REPAYE plan.
IBR and ICR cap your payments at 10% and 20% of your discretionary income respectively if you're a new borrower taking out loans after July 1, 2014. IBR gives you 20 years to pay your loans; ICR gives you up to 25 years.
You can reach out to your federal loan servicer to discuss income-driven repayment options and apply for a plan. Once you have a payment plan set up, either for federal student loans or private student loans, the next step is making timely payments.
Enrolling in your loan servicer's auto-pay option can make this easier. As an added incentive, your loan servicer might offer an interest rate discount for setting up automatic payments. If auto-pay isn't an option, you can also ensure timely payments by setting up payment reminders through your bank.
And paying on time doesn't just go for your student loans either. You should also make a point of paying all of your other bills (rent, utilities, credit cards and other debts) on time each month as well. Again, automatic payments may be the easiest way to avoid being late, but you can also set up bill payment alerts so you don't miss any due dates.
Open a Secured Credit Card
Credit cards can be one of the fastest ways to rebuild credit after defaulting on student loan debt. Your credit scores are based largely on payment history; but after that, credit utilization is the second-most important factor.
Credit utilization refers to how much of your available credit you're using at any given time. When you use a credit card to make purchases and pay them off on time, keeping your credit utilization low in the process, this can help to improve your credit score.
If you have bad credit because of loans in default status, getting approved for a traditional credit card may not be so simple. You may need to get a secured credit card instead.
Secured credit cards require a cash deposit, which typically doubles as your credit line. For example, the card issuer may ask for a $200 or $500 deposit and, once your account is open, you'd have a $200 or $500 limit.
Secured cards work much the same as regular credit cards, in that you can make purchases against your credit limit and then pay them back with interest. Making timely payments to a secured credit card can help you re-establish positive credit history. And with some card issuers, you may be able to have your account converted to an unsecured card and your deposit refunded after several months of responsible use.
When comparing secured credit cards, consider:
- How much of a deposit the credit card company requires
- Whether that deposit can be refunded later
- The annual percentage rate and fees
It's also important to make sure that a secured credit card issuer reports your account activity to the credit bureaus. Otherwise, making timely payments and keeping your credit utilization low won't help to improve your credit history. Once you've had your account for a few months, you could try requesting a credit limit increase. Having more available credit could help improve your credit utilization ratio and your credit score, as long as you continue to keep the balance on your card low.
Consider a Credit Builder Loan
Credit cards are just one option for rebuilding bad credit; you might also consider a credit builder loan.
Credit builder loans can be offered by banks, credit unions and online lenders. These loans are similar to secured credit cards, in that they may require a cash deposit as collateral. With some loans, your savings account may serve as collateral.
Once you repay the loan, the money used as collateral for the loan is returned to you with interest earned. In the meantime, your on-time payments are reported to the credit bureaus, helping you to improve your credit score.
Similar to a secured credit card, check the details of a credit builder loan before applying. Make sure you understand the interest rate, fees, loan repayment term and monthly payments as well as what's required to secure the loan beforehand.
Be Patient When Rebuilding Bad Credit
Rebuilding credit history after defaulting on student loans can take time and you may not see results overnight. Being consistent with responsible credit habits, such as paying on time and keeping your credit card balances low, can go a long way toward making progress.
As you work on rebuilding your credit, remember to check your credit reports regularly to see how you're doing. You can check your credit report for free online. While you're reviewing your credit reports, also check for errors that could be hurting your credit score. If you spot an error, reach out to the credit bureaus to have it removed or corrected, which could give your score a boost.