Student Loan Defaults: Be Careful Not to Make This Huge Mistake

NEW YORK (MainStreet)—With looming student loan payments each month, borrowers may find it tempting to skip a payment or two, especially if their payoff date is being counted in years and not months.

While you might forget that you missed a payment once or twice or were late by merely a few days, your future lenders are likely to remind you of your blunder. Mistakes like this can result in serious consequences.

Even if you are late once with your student loan payment, government and private lenders such as Sallie Mae and banks will report your tardiness to credit bureaus.

Your credit score is examined by various lenders when you try to obtain debt from a credit card company or purchase a house or car. Most lenders use the FICO score to assess your credit, the amount of money you can borrow and the amount of interest you will pay.

Having a strong and high FICO score means you can receive the lowest interest rates on loans and obtain higher quality credit cards.

Student loan repayment affects your credit rating just like any other credit obligation. When you are late paying your student loan by even 30 days, the occurrence is reported to the credit bureaus and will lower your score.

Since FICO reports that payment history makes up 35% of the FICO score, it is critical to make your loan payments on time.

If you accidentally forgot to pay your student loan or missed it by a few days, it is possible the loan servicer may report it to the credit bureaus, said Dean Obenauer, assistant director of Financial Aid for Financial Literacy at Creighton University in Omaha, Neb.

"It may ding the credit score some, but then the score will go back up when on time payments continue," he said. "If it is the only late payment, it shouldn't impact the score much. However, if it is one of several accounts that are late, the impact could be more severe."

Some late payments appear on credit reports for several years, Obenauer said. He has reviewed some credit reports where the past five years of payment history is listed.

Missing a payment by 30 days has a greater impact on your credit score if you are a recent graduate and don't have much credit established yet, said Jeff Golding, CEO of WilliamPaid, a Chicago-based company which allows people to build credit through paying their rent online.

You can reverse any damage done to your credit score and start to improve it once you start to make consistent payments on time. For instance, if you show a history of making late payments only on your student loans for two years, but later you establish two years of consecutive payments on time, it is likely you can return to your previous credit score, Golding said.

Defaulting on a student loan is when a borrower has not made a payment in nine months and can have disastrous results that affect your credit history for up to ten years from paying higher insurance rates or being denied a job by an employer.

In addition to being denied additional financial aid, your wages and tax refunds can be garnished, and you can lose a professional license as a nurse, doctor or CPA, Obenauer said.

When lenders or creditors perform a credit check, they are very unlikely to approve credit when a defaulted loan appears on the credit history, he said. Credit checks can be pulled by anyone with a permissible financial purpose, such as a landlord or auto lender.

"The landlord could increase the amount of the security deposit based on an unsatisfactory credit check or not even approve the application at all," Obenauer said. "For a car loan, the lender/auto dealer could charge the borrower much higher fees and interest rates if the credit history is not good. There is no reason for a borrower to default on a student loan as long as they stay in touch with the loan servicer."

Once you have defaulted on a student loan, the issue is that the entire loan becomes due immediately and you lose the right to pay in installments, said Golding. However, most lenders will work with you to set up a payment schedule.

Borrowers should seek other options such as deferment, forbearance or debt consolidation instead.

"For federal student loan borrowers, there are several options," he said. "There are new income based repayment plans which calculate monthly payments based on discretionary income to lower the required monthly payment. Most deferments and forbearances are granted for a few months at a time, but may be extended if circumstances have not changed."

Private lenders such as banks and credit unions also offer deferment, forbearance or reduced loan amounts available.

If you have incurred a massive amount of student loan debt, but make payments on time; it can help raise your credit score, said Golding.

"Having a longer credit history helps your score because it shows you can manage debt," he said. "Having student debt is not bad as long as you can afford to pay it."

Borrowers should consider all their options to reducing their payment amount.

"Make sure you take advantage of all the programs out there to keep yourself from falling behind," Golding said. "These are the things that haunt you over time. If you are late by a few days, make a payment immediately and contact the lender. You should never miss a payment because you are careless."

For more information about your options to pay off your student loans, click here: http://www.consumerfinance.gov/students/.

--Written by Ellen Chang for MainStreet

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