Does Paying Off Defaulted Student Loans Affect My Credit Score?

‍Paying off student loans in default can help improve your credit score — but only if the loans are on your credit report.

If your federal or private student loans are in default, paying them off may help improve your credit score. Newer FICO and VantageScore credit scoring algorithms ignore collection accounts with a zero balance. But some lenders, especially mortgage companies, use older credit scoring models that include defaulted loans that you’ve paid off.

Keep reading to learn about paying off defaulted student loans and your credit score.

Your credit score may improve if you pay off student loans in default. But it likely won’t lead to a significant increase. Your score will experience the biggest jump after the late payment history falls off your report in seven years.

But what if my defaulted loans aren’t on my credit report? If your student loans fell off your credit report, paying the balance won’t affect your score. It won’t increase because the loans were no longer dragging your score down. And it won’t decrease because the loan servicer won’t add the loans back to your credit history. Read more about what happens if your student loans were removed from your credit report.

Still, besides raising your score, other benefits make it worthwhile to pay back your debt from college — especially defaulted federal student loans.

When you get federal student loan debt out of default, you’ll:

• Qualify for income-driven repayment plans, deferments, forbearances, and loan forgiveness programs.

• Protect your paycheck from wage garnishment, tax refund from seizure, and Social Security benefits from offset.

• Remove your name from the CAIVRS report so you can borrow an FHA mortgage.

• Regain eligibility to receive more financial aid.

The only benefit private lenders and collection agencies offer to student loan borrowers who pay defaulted loans is a settlement for less than the balance owed. The loan holder typically won’t agree to delete the negative information from the three major credit bureaus (Equifax, Experian, and TransUnion).

Learn More: How to Get Student Loans Off Your Credit Report

Usually, paying off a student loan shows lenders you managed the debt responsibly. It also shows you have more disposable income to pay a new loan, which increases your creditworthiness. But paying back your debt after student loan default doesn’t prove you can make on-time payments. It simply demonstrates that you’ll eventually make good on your obligations.

Some lenders may view paying off delinquent student debt as a sign that you can be trusted to repay debt. But you might still have trouble qualifying for new lines of credit, such as student loan refinance loans, personal loans, or credit cards. And even if you do qualify, you likely won’t get the lowest interest rates and best repayment terms. Lenders reserve those perks for borrowers with good credit.

The Department of Education offers borrowers three options to get out of default:

• Repayment. The full loan balance is due when student loans default. You can pay that amount if you can afford it or negotiate a settlement for less than what’s owed. Don’t expect big savings, though. Read more about how to settle student debt.

• Rehabilitation. Student loan rehabilitation removes the default status on your loans after you make nine monthly payments within 20 days of the due date for 10 consecutive months. Ordinarily, the payment amount is 15% of your discretionary income unless you request to pay based on your personal finances. But during the interest-free payment pause, you can choose not to make the student loan payments. Read more about student loan rehabilitation and the CARES Act.

• Consolidation. Paying off loans in default with a Direct Consolidation Loan makes sense if you can’t afford a settlement and need to resolve the default quickly. Unlike refinancing, you can consolidate loans with bad credit. To qualify, you must make three consecutive monthly payments based on your income and family size or agree to repay your new loan under an income-driven repayment plan. Read more about consolidating defaulted student loans.

The best option for you to fix the student loan default and return your loans to good standing depends on your situation. Read more about how student loan default affects your credit score.

Learn More: How to Get Student Loans Out of Default

• Pay your bills on time. While there’s little you can do about the missed payments that have dragged your score down, you can raise it back up by paying your bills on time. If you have other student loans, consider enrolling in a payment plan based on your income. Lenders are looking for blemish-free payment history, so they trust that you’ll consistently pay them, too.

• Keep your utilization low. Credit utilization refers to how much of your credit you use. Low utilization correlates with higher credit scores because it shows that you use your credit cards wisely and don’t rely on them too much. High utilization indicates just the opposite. It suggests that you’re not managing your debt well and may be in danger of defaulting on your payments. Keep your credit utilization rate below 30% overall and on each credit card.

• Diversify your credit mix. If you have only student loans on your report, try to get a secured credit card or become an authorized user on someone else’s account. Maintaining a varied mix of credit demonstrates that you can manage several kinds of loans.

Paying off your student loans in default can help improve your credit score, but it’s important to understand the different options available to you and how they can affect your credit. If you’re not sure what to do, consider speaking with a student loan advisor who can help you choose the best strategy for your situation.

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