Tag Archives: IBR

How My Credit Improved Thanks to $100K In Student Loans

interest rateSome years ago (in a different financial life, so to speak), I got really sick, and was hospitalized for several days. As most of us know, hospitalizations are quite costly – and the pain is double when you don’t have health insurance, such as when you’re between jobs or working part-time or in a freelance capacity.

I applied for financial assistance, and the hospital mercifully reduced many of the fees. But the doctor’s bills, ambulance and related procedure costs weren’t, leaving me with thousands of dollars in bills and no way to pay them off efficiently.

So, being an imperfect (and unemployed) human, I fell behind on my payments. Some of them ended up in collections. Naturally, my credit score suffered.

Fast forward several months later. Still unemployed during the depths of the recession, I decided it was an opportune time to further my education by getting an M.B.A. My credit was still blemished, but I managed to qualify for federal student loans, anyhow.

Over $100,000 of them.

Now, you might think this was reckless. You might say that having already weakened credit, the last thing I should do is pile on more debt. You might also suggest that if I didn’t manage to get a high-paying job out of business school, I’d be in doubly-deep poo-poo credit-wise.

And you’d be wrong.

Why my credit actually improved

It turns out I didn’t manage to get a high paying job on graduation; it took me several months to find any job at all.

But the $100k+ in student loans weren’t hurting my credit. In fact, they were helping it. In fact, my score rose over 100 points, taking me from the mid-500s range known as “poor” credit to the higher 600s range knows as “good”.

As credit expert, John Ulzheimer notes, installment debt such as student loans have a negligible impact on your credit.

But there were other factors at work here.

For starters, I didn’t default on my loans. You can be certain that should I have done so, my credit would’ve plummeted.

Instead, my loans were initially deferred until I started working. Once I started working, I began making payments under the federal Income Based Repayment plan (known better as IBR), which caps your monthly payments at 15% of disposable income.

It thus appeared on my credit report — and score calculations– that I was “on time” and managing the hefty $100k in loans responsibly. It was showing I was a good credit, even when I was jobless with over $100k in debt.

Many of my old medical debts which I hadn’t yet finished repaying were still on my credit report during this post-M.B.A. unemployment, too, so I couldn’t attribute the improvement to them being erased, or anything similar.

Nope, it was just the very fact that I had the debt and wasn’t defaulting.

And now that I am working full-time and earning an M.B.A salary, my credit has continued improving, especially as I’ve now paid off those old medical debts, too.

The moral of the story here is simple:

Credit scoring is a system full of quirks. Not all heavy debt burdens are equal, and depending upon your starting credit, it can sometimes even be beneficial (especially things like student debt, which can ostensibly lead to better earnings potential). We’d always advise you to be prudent with any debt, but this story demonstrates how, if you avoid outright default, few debt situations are without hope.

Federal Student Loan Debt Relief & Repayment Options

recessionIt’s a fact almost universally acknowledged that burgeoning student loan debt is crushing an entire generation, leaving students and parents in a state of financial shock. Defaults on both federal student loans and private loans are on the rise, and in an effort to help student borrowers cope with soaring education costs (and perhaps to brighten the state of public sector employment), the government has created new federal debt repayment programs. If utilized properly, these can help graduates better manage the cost of student loans.

  • Income Based Repayment Plan: As a part of the College Cost Reduction and Access Act, the IBR (or Income Based Repayment) plan was introduced on July 1st, 2009. This particular plan is capable of significantly reducing the monthly payments of those borrowers carrying heavy debt load relative to their income.(Check out this IBR calculator to see if you qualify & how much your monthly payment would be.) For eligible federal student loan borrowers, IBR lowers your repayment cost to a maximum of 15% of your disposable income, and after 25 years, any remaining debt is forgiven. Plus, the federal government may cover interest rate payments on subsidized Stafford Loans for up to 3 years. Also worth noting: If you work for the government, in education or for a non-profit, your remaining debt will be forgiven after 10 years of IBR payments.
  • Pay As You Earn: Introduced on 21st December, 2012, PAYE is in many ways pretty similar to IBR. However, the PAYE program caps student loan payments at 10% of discretionary income, instead of 15%, making it even more affordable. It will also cover unpaid subsidized interest payments during the first 3 years of repayment, and any remaining loan balance will be forgiven after 20 years (or 10 if you’re in government/non-profit work). However, only borrowers with loans issued entirely after October, 2007 qualify – for everyone else, there’s IBR.
  • Economic Hardship Deferment: The CCRAA re-defined  financial hardship, thereby resulting in changed qualification criteria for Economic Hardship Deferment or EHD. Graduates that previously qualified for this may no longer be eligible, and might instead choose forbearance, which is a more expensive option than EHD. The best alternative to EHD is actually PAYE or IBR, and EHD should be reserved for returns to school or medical residencies.
  • Income-Sensitive/Graduated Repayment: On the surface, income-sensitive repayment seems similar to IBR and PAYE, since it enables you to make lower monthly payments based on your income level. But that’s where the benefits stop. Unlike IBR and PAYE, there is no loan forgiveness or subsidized interest subsidy, so there’s little advantage to choosing this option. Similarly, graduated repayment enables you to make lower monthly payments at the beginning of your re-payment term, possibly extending the term of your loan or ballooning to much larger payments down the road. This plan also doesn’t offer loan forgiveness or interest rate subsidies, so it also doesn’t offer the benefits of IBR/PAYE.

The bottom line is this: Even if you can afford to pay down federal student loan debt on-schedule (or even better – ahead of schedule), IBR and PAYE make more sense than any other federal repayment plan currently on the market. The reason is simple: They provide you with the possibility of loan forgiveness and interest rate subsidies should your earning potential ever decline, and don’t penalize you for early re-payment, should your income and ability to re-pay increase. And of course, if you don’t earn enough to re-pay your loans per a standard re-payment plan, they also save you money over forebearance (or God forbid, default.)