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I Filed Bankruptcy and Now Need to Get My Student Loans and Credit Score Rehabilitated. – David

“Dear Steve,

First off, I’d like to say thanks for your site. Your answers to other people’s questions has really helped me plan my own bankruptcy recovery (monitor my reports, use a secured credit card to help reestablish credit). However, there’s one thing that I haven’t seen come up, so I’d like to ask: student loans. I’m sure everyone who has filed bankruptcy knows that their student loans don’t go away. I’d like to know how to approach repaying these loans so that it benefits my credit score as best it can while I recover my credit.

To be specific, here is my situation: I filed for bankruptcy a few months ago and it should be discharged soon. At the same time, the company I was previously contracted to has hired me on full time and this month I landed another contract that will bring in some extra money. While this is not enough to completely pay off both student loans, it is enough to pay off one and help me establish regular payments on the other.

The larger of the loans is currently in deferment while the smaller is in default. Since I will have enough money over the coming year to pay off the smaller loan completely, should I, and how should I? Simply put, should I throw all the money I can at the loan as fast as I can and pay it off up front, or should I get the loan on a “rehabilitation” agreement? With such an agreement I could pay the agreed upon monthly payments for a year, and then pay off the remaining balance at the end. Would it benefit me to have that payment history on my credit report, or should I just focus on paying off the loan quickly? For the larger loan I plan to enter a normal repayment cycle when the deferment ends, though I may put whatever extra money I can into it after the smaller loan has been paid off.

I do understand there is also a “cost” argument here… if I were to pay off the loan quickly I would be paying less interest, and the money that I would have been paying could be put into earning interest instead. I’m not horribly concerned with this, however. I would gladly “spend” that bit of money now if it will help my credit score in the long run. I know I screwed up, I accepted that when I filed for bankruptcy… now I would like to repair my credit so I can look into buying a house in the coming years.

Should I pay my student loan off completely while I have the money to do so, or should I reestablish monthly payments on it? Which approach will benefit my credit score more in the end?

David”

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The Answer

 

Dear David,

Excellent question!

I would first get yourself in a rehabilitation agreement with the defaulted student loan. If this is a government backed loan and you make nine on-time payments the past bad history on this can be removed from your credit report by request.

At the same time, if you can afford it I’d like to see you leave the deferred student loan alone and take all your extra cash and build up your emergency fund. Once the loan comes out of deferment you could make the payments on the two loans and keep adding funds to your emergency fund / savings account.

Once you are in that position you are then much safer than where you are now. Let’s be clear though, leaving the one student loan in deferment and socking away all the cash means the student loan is building interest. But the cost of not having an emergency fund to fall back on in case of an emergency is a true financial catastrophe.

I think if you approach this in stages and also combine it with the advice offered here, “I Filed Bankruptcy. How Do I Legally Rebuild My Credit? – Janet“, you will emerge in absolutely great shape.

Big Hug!

I Filed Bankruptcy and Now Need to Get My Student Loans and Credit Score Rehabilitated.   David
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About Steve Rhode

Steve Rhode
Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
  • David

    Very nice, that’s exactly what I was thinking I would do. To be specific, the loan in deferment has a very low interest rate (1.8%, how did I manage that?), while the defaulted loan has a 5% interest rate. So, as I see it, I can put that money into a savings account with a 3-4% interest rate while it’s in deferment and I’m still coming out on top by a small margin.

    So, once I have reestablished the payment history on the defaulted loan, removed the default from my credit history, built up a bit of savings, and established a secured card or two to rebuild my credit… it wouldn’t be a problem to pay off the rest of the defaulted loan completely if I can afford it? It seems to me that since it is the higher interested rate that wouldn’t be a bad idea, so long as I don’t hurt myself doing it.

    • http://GetOutOfDebt.org Steve Rhode

      David,

      The savings account is going to pay very little but the rate of return isn’t the value of it, it’s the security net it gives you in case of a sudden need for cash without having to run to credit.

      Once we get everything stabilized then focusing on either the smaller balance loan or the highest interest rate loan, which ever gives you the most emotional drive to keep paying them off is the way to go.

      Glad I was able to help.

      Steve

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