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The average credit score of student loan borrowers just went up, but here's why that's a red flag

A recent report by the Federal Reserve Bank of New York shows that student loan forbearance granted by the CARES Act caused borrowers' credit scores to increase, but experts say to be wary.

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With federal student loan payments on pause since the CARES Act passed in late March, millions of borrowers saw their federal direct student loans automatically go into forbearance — and their credit scores increase.

In fact, according to a new report from the Federal Reserve Bank of New York, the average credit score of all student loan borrowers increased nine points, from 647 in March to 656 in June.

The CARES Act protections have prevented borrowers' accounts from falling into delinquency, says higher education expert Mark Kantrowitz. Although the repayment status of federal student loans is reported to all three credit bureaus, the CARES Act specified that paused student loans should be reported as current on credit reports, Kantrowitz tells Select.

The Fed's report suggests that, as a result, easing these delinquent loans as they entered into forbearance caused an uptick in credit scores.

But while the postponement period has provided relief to many borrowers who needed it, experts warn this fresh start is only temporary.

"The forbearance will eventually come to an end, and credit scores will come back down to Earth," says Gordon Achtermann, a Virginia-based certified financial planner.

Select spoke with student loan experts about why borrowers should be wary of these programs even if they've seen their credit scores increase.

Why an increased credit score is a red flag

The coronavirus-related safety nets available to student loan borrowers have presented a great opportunity for struggling consumers to regain stability and avoid default, says Bruce McClary, a spokesman for the National Foundation for Credit Counseling (NFCC). Yet, he warns that the underlying circumstances that caused individual financial hardships in the first place — such as a lack of savings or too much credit card debt — may not be resolved before the federal student loan deferment program expires.

Unsecured consumer debt sits at an all-time high of $1.4 trillion, McClary says, and those who have reached out to the NFCC asking for help managing their debt come with an average of $16,000 in debt across five credit card accounts.

"Even with some recent increases in savings rates among consumers, most Americans are nowhere near where they need to be to survive another major financial disruption," McClary says. "A recent example of this is from last year's federal employee furlough. It was only a matter of weeks before many families ran out of cash after their paychecks stopped.

"That leads me to believe that some will end up right back where they were or worse when the moratorium on payments and interest comes to an end," he says of student loan borrowers.

Travis Hornsby, a chartered financial analyst and founder of Student Loan Planner, has his own fears. He's concerned that the longer borrowers suspend their payments, the greater the likelihood they will spend the money they would have used on student loans toward other things. Then, when the suspension is eventually lifted and payments start again, these borrowers won't have the money left to pay them.

For borrowers facing prolonged periods of hardship, make plans beyond the temporary relief programs and consider affordable repayment options that can help keep your loans out of default.

To take advantage of their improved credit scores and record low interest rates, student loan borrowers should consider refinancing any debts, including private student loans. "Now is the time to do it," Achtermann says. 

Just be sure you understand any fees involved and note that you'll likely need more than just good credit to qualify for a refinancing; you'll also have to show steady employment, Kantrowitz says.

How student loans affect your credit score

If your credit score went up in the last few months, it's important to note how it can just as easily go back down as the federal protections end. (President Donald Trump's latest memorandum extends the relief until the end of the year.) 

Your student loan payment history has more impact on your credit score than your overall balance, Hornsby notes. In fact, he says, credit bureaus don't seem to care if you owe five times your income as long as the required payments get made on time and in full. 

"Someone with $10,000 of delinquent debt might have a credit score 200 points lower than a dentist who owes $700,000 but who makes their $700-a-month income-based payments on time," Hornsby says.

For any sort of borrower, making sure your loans and credit card balance are paid on time (and in full if you can) should be a fundamental financial goal.

To keep track of your credit score, sign up for a free service like CreditWise® from Capital One and Experian Boost™. If you don't mind paying a monthly fee for additional services, consider our top-rated credit monitoring services IdentityForce® or FICO® Advanced for the most accurate credit score updates.

To learn more about IdentityForce®, visit their website or call 855-979-1118.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.