By Andrew Welsch

The U.S. Department of Education is once again collecting payments on defaulted federal student loans -- and millions of Americans could see their credit scores drop as a result.

The department said last month that it would resume collections on May 5 after a five year pause and threatened to take punitive actions against borrowers in default, including garnishing wages and withholding tax refunds. At the time of the April 21 announcement, the department said more than 5 million borrowers were in default and an additional 4 million borrowers are in late-stage delinquency, meaning they were 91 to 180 days late on payments.

Economic impact. Restarting collections may put a burden on borrowers, forcing them to cut back spending elsewhere. Analysts at Morgan Stanley think the resumption of collections will have a "relatively small" impact on gross domestic product, but the consequences for individual borrowers could be significant and fall disproportionately on younger Americans.

Consumers under age 40 account for more than 50% of student debt, according to the Morgan Stanley analysts. "Middle- and high-income consumers have more student debt, but low-income consumers are more likely to be delinquent," they write in a May 5 note.

Consumer spending ties. Some borrowers may see their credit scores take a hit, making it harder to borrow money to purchase automobiles, homes, and other consumer goods.

"More consumption headwinds may further dampen investor growth expectations, allowing for lower implied Fed policy rates and a steeper UST curve," the Morgan Stanley analysts write, referring to the U.S. Treasury yield curve.

In the first Trump administration, the Education Department paused student loan payments during the pandemic. The Biden administration then extended the pause, and also attempted to forgive some student loans, efforts that were blocked by the Supreme Court.

Pandemic forbearance improved the credit scores of delinquent and defaulted borrowers, according to two researchers at the Federal Reserve Bank of New York's Research and Statistics Group. For instance, the 2020 forbearance (which marked delinquent but not defaulted loans as current) improved the median score between the fourth quarter of 2019 and fourth quarter of 2020 for delinquent borrowers by 74 points. That increased their score from 501 to 575, researchers Daniel Mangrum and Crystal Wang wrote in a March 26 note. Since then, their credit scores continued to rise.

The positive trend was already in jeopardy before the Trump administration began resuming collections. The researchers note that required payments on federal student loans resumed in September 2023, but the Biden Administration created an on--ramp for borrowers so that missed federal student loan payments would not adversely impact credit scores for one year.

"The on-ramp protecting student loan borrowers from negative credit reporting ended in September 2024 but since it takes at least 90 days of missed student loan payments to be reported delinquent, adverse credit reporting for delinquent federal student loans is only now beginning to appear on credit reports," the authors wrote.

The authors estimate more than nine million student loan borrowers face substantial declines in credit standing over the first quarter of 2025.

A representative for the Education Department didn't respond to a request for comment. In April, the department said it was resuming collections as a matter of fairness.

"American taxpayers will no longer be forced to serve as collateral for irresponsible student loan policies," U.S. Secretary of Education Linda McMahon said in a statement. "Going forward, the Department of Education, in conjunction with the Department of Treasury, will shepherd the student loan program responsibly and according to the law, which means helping borrowers return to repayment -- both for the sake of their own financial health and our nation's economic outlook."

Write to Andrew Welsch at andrew.welsch@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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May 05, 2025 13:12 ET (17:12 GMT)

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