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Will Signing Up For IBR, PAYE or REPAYE Help My Credit Score?

Michael Lux Blog, Student Loans 22 Comments

One of the big advantages of federal student loans is the income-driven repayment (IDR) plans.  The most popular plans are Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE).  What makes these plans special is that your monthly payment is based upon what you can afford to pay rather than what you owe.  As a result, most student loan borrowers can qualify for lower payments.

Will signing up for IBR, PAYE, or REPAYE hurt my credit score?

Many consumers already know that enrolling in a payment plan to settle debt can hurt your credit score.  This usually happens when a lender reports to the credit agencies that the borrower is “paying partial payment agreement” or that the debt “settled.”  These terms can be red flags for future creditors.

Signing up for an income-driven plan is different.  Even though some of the IDR plans require a “partial financial hardship,” there is no hardship or partial payment designation on your credit report.  In fact, the “partial financial hardship” required for some IDR plans simply means that signing up for the plan would save you money over the standard repayment plan.

Because there is not a negative designation associated with signing up for IBR, PAYE, and REPAYE, there should be no harm to your credit score.

However, as noted in the comments section below, there can be some negative consequences to signing up for one of the Income-Driven Repayment plans.

Will signing up for an income-based repayment plan help my credit score?

Signing up for IBR, PAYE, or REPAYE is a powerful option because it can free up money each month and get you started on the path towards student loan forgiveness.  Unfortunately, the direct impact on your credit score is minimal.

This is because your monthly payment is altered.  Your credit history remains the same.  Signing up for an income-driven repayment plan will not erase past mistakes.

However, signing up for an income-driven repayment plan can have a couple of indirect benefits to your credit overall.

How can income-driven repayment help my credit?

For those looking to build good credit to buy a house or qualify for lower interest rates in the future, signing up for IBR, PAYE, or REPAYE can be very helpful in two ways.

  1. IDR plans help your debt-to-income ratio – Even though the direct impact on your credit score may be minimal, an income-driven repayment plan can dramatically improve your debt-to-income ratio (DTI).  Your DTI compares your monthly bills as reported on your credit report to your monthly income.  The more income you have compared to your debt, the better your odds of getting an approval are.  By reducing your monthly obligation on your credit report, lenders will see that you are in a better position to afford a mortgage or car payment.
  2. IDR plans help avoid missed payments – Repaying student loans on the standard repayment plan can be very difficult for many borrowers.  If you are barely getting by on your current student loan plan, you could be one illness away from a missed or late payment.  Signing up for income-based repayment can allow a borrower to start saving an emergency fund to ensure that there are no payment issues in the future.  Put simply, lower payments mean more flexibility and financial stability.  A missed or late payment can have a devastating impact on your credit score.  Finding a way to prevent this from happening is a major win.

Some borrowers also choose to consolidate their federal student loans as they begin repayment.  Consolidation of student loans is another avenue that can potentially help credit scores.

What are the Possible Negative Consequences to IDR Enrollment?

Some borrowers who sign up for an Income-Driven Repayment plans can qualify for monthly payments of $0 based upon their income. These zero dollar payments count towards student loan forgiveness and can be really helpful for a borrower who is unemployed or underemployed.

The downside to zero dollar payments is that loan balances will go up because the loan continues to accrue interest. Borrowers in this situation should understand the events that trigger interest capitalization and avoid them when possible.

The credit score consequences of an increasing balance without missing a payment are a matter of some debate. Credit bureau Experian appears to argue that not making payments will not directly hurt your credit score as long as it is authorized by the lender. Lender Sallie Mae says that the increasing balance could have an impact on your credit score, depending upon how the information is reported. Several readers have also stated that the increasing balance has caused their credit score to drop.

At this point, it is worth noting that IDR enrollment by itself does not have a negative credit consequence. The borrowers who have monthly payments that are less than the monthly interest accruing on the loan are the ones reporting an issue. Borrowers in this situation are permitted to make payments larger than the monthly interest accumulation if they are concerned about their credit score being hurt.

The other conceivable downside for a borrower who qualifies for $0 monthly payments comes when applying for a mortgage or other loan. When a credit agency sees $0 for the monthly payment, they will often substitute 1% of the loan balance as the monthly payment for Debt-to-Income ratio calculations. In the past, the 1% figure was used for most mortgage applications, but recent changes to mortgage underwriting changed this rule. Borrowers with $0 payments will still get hit with the 1% rule, but most other borrowers will have their actual monthly IDR payment used.

Bottom Line

Signing up for Income-Based Repayment, Pay As You Earn or Revised Pay As You Earn may not directly help or hurt your credit score.  However, the indirect benefits can be large, and going the income-driven repayment route can have a positive impact on your ability to get credit.

Many borrowers consider an income-driven repayment plan because they are unable to make the full payments on the standard repayment plan. If a late payment is a serious risk due to unaffordable large bills, switching to Income-driven repayment should be an easy decision. The credit score implications of signing up for IBR, PAYE, and REPAYE are relatively small compared to the devastating consequences of late payments, delinquencies, and defaults.