Transferring Loan Accounts Damage Borrower Credit

A student loan borrower may be contacted by the marketing arm of a Federal student loan service provider for the Education Department (ED) at any time during the term of the loan. The borrower will be asked to transfer their accounts to that provider in exchange for attractive incentives such as a lower interest rate or longer term. But borrowers should be aware that loan account transfers from one service provider to another have the potential to harm their credit score. If they choose to transfer their loan account, they should manage the transition closely.

The unintended creation of duplicate loan accounts is what may harm the credit of borrowers whose loans are transferred. The ED has confirmed the existence of 1.4 million duplicate account records. ED has not yet notified all of these borrowers, so many of them remain unaware of the problem even as it’s harming their credit score. Borrowers who have discovered the error on their own complain about the long delay in its resolution.

The duplicate account problem originated in a 2021 change in how service providers, who manage the ED’s $1.6 trillion student loan portfolio, report transferred loans to the three national credit bureaus: Equifax, Experian, and TransUnion. Prior to 2021, the service provider transferring the loan would close all records associated with the account and the receiving service provider would open a new account.

Since 2021, however, the ED has required that the service provider receiving the student loan account submit a notification file to the three credit bureaus signaling that the debt has been transferred from the previous service provider. The previous provider’s account history is provided to the new servicer and is retained by them. The problem stems from the fact that the credit bureaus haven’t been processing the notification files sent by service providers because they haven’t yet updated their systems to comply with the 2021 change.

The ED’s Federal Student Aid (FSA) office alerted the credit bureaus about the fault in their processes last year. A temporary workaround to avoid duplicate accounts is in use today and the FSA said the credit bureaus would roll out a permanent solution later this year.

By implementing the practices recommended in this post, student loan borrowers can avoid or resolve duplicate accounts, improve their credit scores, and increase the chances that they will be approved for home mortgages, collateralized loans such as auto loans, and uncollateralized loans such as credit cards after they graduate from college.

Impact on a Borrower’s Credit

Transferring student loan accounts can harm a borrower’s credit score, but this outcome depends entirely on how well the transfer is handled. If the transfer creates a duplicate account, the borrower’s credit will be damaged. If the transition is handled correctly, it will not. Below is information for borrowers to consider before transferring an account:

1. Credit Inquiry: A new lender of a mortgage, credit card, or other type of credit arrangement will perform a hard inquiry on the borrower’s credit report. A hard inquiry is a request to a credit bureau from a lender for a potential borrower’s credit score. These inquiries themselves have an impact on credit scores.

2. Account Age: Closing an old credit account and opening a new one lowers the average age of a borrower’s credit accounts. Age is a plus factor in credit scores.

3. Payment History: Maintaining timely payments during and after the loan transfer is crucial. Missed or late payments have a negative effect on a score.

4. Debt-to-Income Ratio: The total amount of debt that the borrower carries relative to income might change with different loan terms or balances, affecting lenders perceptions when applying for future loans.

To minimize potential damage to their credit scores after a transfer, borrowers should ensure that all payments are made on time and monitor their credit reports for any post-transfer discrepancies. For personalized advice tailored to specific situations, consulting with a financial advisor or credit counselor is recommended.

Even a Temporary Drop in Credit Score Can Be Harmful

A hard inquiry typically results in a temporary drop of about 5 to 10 points on a credit score. The exact impact varies based on several factors:

1. Credit History: If the borrower has a long and positive credit history, the effect will be less than that on a person with a short or negative credit history.

2. Number of Inquiries: Many hard inquiries within a short period can compound the negative effect.

3. Overall Credit Profile: Overall credit utilization, payment history, and average account age play roles in how much a hard inquiry affects a credit score.

Typically, any drop in credit score from a hard inquiry is temporary; most borrowers see their scores recover within a few months as they make timely payments and manage their accounts responsibly. However, the drop in credit score may last up to two years.

The “Short Period” of Lowered Credit Scores After Hard Inquiries

 The short period for multiple hard inquiries typically refers to a window of 14 to 45 days, depending upon the credit scoring model used. Below is a description of the two credit scoring models:

1. FICO Score: For FICO scores, multiple inquiries within a 45-day period are treated as a single inquiry. This allows borrowers to shop around for the best rate and terms without significantly impacting their score.

2. VantageScore: VantageScore has a similar approach but will weigh multiple inquiries within 14 days as a single inquiry.

In addition to FICO, some lenders also use VantageScore. It’s important to note that different lenders may choose a different model based on their needs and risk assessment strategy. Therefore, it’s advisable for borrowers to be aware of both their FICO and VantageScore scores when monitoring their credit health.

Shopping for rates and terms over a short period of time will minimize the impact on a borrower’s credit score, but hard inquiries outside this time frame will be counted individually and could lead to a more significant drop in credit score.

Borrowers Can Access Their Credit Scores

Borrowers can access their FICO and VantageScore scores through several channels:

1. Credit Card Issuers: Many credit card companies provide free access to FICO scores as one of their account services. Some also offer VantageScore.

2. Credit Monitoring Services: Various online platforms, such as Credit Karma, which provides VantageScore, and myFICO, which provides FICO Scores, allow individuals to monitor their scores for free or via subscription.

3. Annual Credit Report: While this report does not include credit scores, borrowers can obtain it from com as a reference.

4. Directly from Credit Bureaus: Borrowers can obtain their FICO Score and VantageScore directly from the credit bureaus.

5. Financial Institutions: Some banks and credit unions offer free access to both types of scores as part of their customer service offerings.

By using these resources, borrowers can stay informed of their FICO and VantageScores. This will help them manage their credit health effectively.

Actions That Can Be Taken to Improve a Credit Score

Aside from pursuing the resolution of a duplicate account problem, a student loan borrower can take a number of actions to improve their credit score:

1. Make Timely Payments: Ensure all loan payments are made on or before the due date. Setting up automatic payments can help.

2. Pay More Than the Minimum: If possible, pay more than the minimum payment to reduce the principal balance faster.

3. Keep Credit Utilization Low: If a borrower has credit cards, they should make minimal or higher payments on time and maintain a low utilization ratio, e.g., below 30% of the credit card account’s limit.

4. Check Credit Report Regularly: Review credit reports for errors and dispute any inaccuracies with com.

5. Avoid New Hard Inquiries: Limit applications for new credit. Each application may result in a hard inquiry that can temporarily lower a credit score.

6. Consider Income-Driven Repayment Plans: If struggling financially, these ED options make payments more manageable and help prevent missed payments.

7. Consolidate or Refinance Loans with a New Provider: This can lower interest rates, simplify payments, and extend repayment terms, making it easier to stay current. However, this would initiate a transfer and possible harm to credit.

8. Maintain Older Accounts: Keep older credit accounts open to lengthen credit history. This has a positive impact on a credit score.

9. Seek Financial Counseling if Needed: Professional advice can provide personalized strategies based on individual financial circumstances.