Everyone makes mistakes. Sometimes things happen that are beyond our control.
After the upheaval following the 2008 financial crisis, it’s not surprising if you have a blemish or two on your credit report. With the collapse of the housing market that same year, home foreclosures shot up a record 81 percent, according to CNN Money.
Though having a home foreclosure on your credit report is now more common than it was a decade ago, it still affects your ability to complete other financial transactions, including refinancing student loans.
Here’s how to handle your student loan debt if you’ve experienced a home foreclosure.
Refinancing your student loans could save you hundreds or thousands of dollars over the life of your debt by lowering your interest rate. It might even lower your monthly loan payment, giving you more breathing room in your budget.
But unfortunately, having a foreclosure on your record lowers your credit score, which could prevent you from refinancing your student loans.
It depends on the effect the foreclosure has had on your credit score,” said David Bakke, a financial expert with Money Crashers. The impact is usually pretty significant.
When you apply to refinance your student loans, lenders look at your credit report and your credit score. In many cases, you will need a credit score of at least 660 or 680 to qualify.
A foreclosure, however, can lower your credit score by a whopping 85 to 160 points, according to FICO. The higher your initial score, the bigger the potential decrease. Even for someone who previously had excellent credit, a foreclosure can lower your score enough to put you out of the running for student loan refinancing.
A foreclosure can remain on your credit report for as long as seven years, said Bakke. If you try to apply to refinance your student loans right after a foreclosure, there’s a good chance you’ll be denied, but that doesn’t mean you should give up hope.
If your home was foreclosed upon, you need to give your credit score time to recover. Though the foreclosure will remain on your credit report for seven years, your credit score could start to improve much sooner.
If you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years,” according to FICO.
Bakke recommended taking other actions that will make the foreclosure less important to your credit score, too. Improve your score by paying down your balances and making all of your payments on time,” he said.
There are many things you can do to improve your credit score, make a plan and take steps to improve your score now. As you give it some time, your score will begin to recover. Once your score meets the minimum required by lenders, you can apply to refinance your student loans.
If refinancing isn’t possible right now, you can try other methods of making your student loan payments more affordable.
Instead of refinancing, Lisa Vignola, a financial advisor at Veritas Wealth Advisors, suggested consolidation.
Consolidation works by combining your old loans into one new loan. If you consolidate your federal loans, for example, you would combine all your federal debt into one Direct Consolidation Loan.
This new loan would have a weighted, fixed interest rate based on your previous loans, meaning you wouldn’t save any money in interest. However, consolidation can lower your monthly payment by lengthening your loan term. Plus, it simplifies matters so you only have to pay one loan servicer each month.
This method does come with drawbacks: It could cost you more money in the long run, and getting a Direct Consolidation Loan might cause you to lose access to certain benefits. But if you need to reduce your payment right now, this option could help. After you consolidate, you can work on improving your credit and revisit refinancing later.
If you have federal loans, Vignola said, programs such as income-driven repayment (IDR) could also help you get your monthly student loan payments under control without refinancing.
The four different IDR plans each have their own requirements, but they all work similarly: Your monthly payment is capped at a percentage of your income and your repayment period is extended to 20 or 25 years.
Again, you might pay more in interest over the life of your loan if you enroll in an IDR plan, but temporarily using this option could help you afford your monthly payments. Once your finances are more secure, you can enroll in a more cost-effective repayment plan or apply for refinancing.
One last option, said Vignola, is to have someone else pay off your student loans. When you get your finances straightened out, you can pay them back using more favorable terms. If you’re lucky enough to get a loan from a family member, you could get ahead without the pressure from strict lenders.
If you follow this route, make the arrangement as business-like as possible. If you take a private loan from a family member, it is always a good idea to get the agreement of the loan in writing,” said Vignola. This makes the terms of the loan clear and both parties will know what is expected of them.
In the end, your best bet is improving your credit so that you qualify to refinance your student loans even after your foreclosure. Some ways to improve your credit include:
Monitor your credit score; when it’s higher than the minimum needed, take a look at your financial situation and decide if it’s time to reapply for student loan refinancing.
As you make moves that improve your credit, that foreclosure will matter less and less. After two or three years you might be in a better position to refinance your student loans, and start saving more money.