Student loans can have a major effect on your credit scoreSo it is helpful to understand the relationship between student loans and credit. For one thing, borrowing and paying off student loans can do wonders for your credit history. On the other hand, a misstep like a missed payment can drop your score.
How student loans can have a positive impact on your credit
Think student debt is bad? Not enough. If you manage your loans responsibly, they can help you get good credit. In fact, student loans can have a positive impact on three of the five main factors that make up your credit score – payment history, length of history, and loan composition – according to Gregory Poulin, co-founder and CEO of Goodly, Administrator of Student Loan Repayment Benefits.
Positive payment history. The most weighted factor in your credit score is your payment history, which accounts for 35% of your overall FICO credit score. That’s why one of the best things you can do to get credit is pay your student loan bill on time and in full every month.
Even if your loans are deferred, such as during school and grace periods, the fact that you are not currently making payments is neutral and will not count against you. During these periods, you still meet the loan conditions.
But some lenders allow borrowers to make small payments – like a $ 25-per-month flat fee or interest-only payments – during deferral to school and the post-graduation grace period, says Mark Kantrowitz. , editor and vice president of research at Savingforcollege.com. “These payments are reported as actual payments against the borrower’s credit history, which has a positive impact if the borrower makes them on time.”
This means that it can improve your credit score if you are making student loan payments, even if you haven’t yet. Starting to pay off your loans early means building a positive payment history – and good credit – much sooner. Not to mention that you will remove some of the accrued interest from your balance.
Credit history. Your credit history shows how long you’ve been using credit, including how long different accounts have been open and active. Lenders like to see that you have a lot of experience using credit, so the longer your credit history the better. It’s also a pretty big factor in your credit score, accounting for 15% of your FICO score.
College students may have had poor or no credit histories from their youth and may not have had the chance to take on many credit cards or loans. And while not all student loans require a credit check, they all show up on the borrower’s credit report. For a student with a limited credit history, this can have a dramatic impact on their credit, says Kantrowitz.
By taking out student loans, you start your credit history sooner than if you waited until after graduation to borrow money. While no one should take on debt just for the sake of their credit rating, starting to build credit early is a big advantage of student loans.
Mix of credits. In addition to a long credit history, lenders like to see another. That’s why your credit mix, or the types of credit used, still makes up 10% of your FICO credit score, Poulin says. Whether it’s auto loans, credit cards, mortgages, or student loans, the more types of credit you have on your record, the better your score. Plus, if you don’t have a long credit history, the right mix of credit can have even more of an impact.
How Student Loan Debt Can Affect Your Credit
While student loans can be good for your credit, it’s also easy to get into trouble. If you aren’t careful with payments or take on too much debt, your credit score can suffer.
Missed payments. Remember how important the payment history is to your credit score? The last thing you want to do is miss a payment. “Since payments represent 35% of credit history, missing and late payments have a negative impact,” says Poulin.
The severity of a missed payment will depend on how late and how often you tend to miss payments. The later it is, the more damaging its impact. Even so, a single payment 30 days late could drop 90 to 110 points for someone with a score of 780 who has never missed a payment in the past. Additionally, Kantrowitz cautions that missing payments will also negatively impact the credit of any co-signer on your loans.
While deferral and withholding will not negatively affect your payment history, all missed payments before the plan is implemented are negative. If you’re having trouble making payments, talk to your student loan manager before you miss one.
Default. If you really let your student loan payments slip, you could find yourself in default. It is a much worse situation for your credit.
For most federal student loans, your loan is considered past due if you are at least 270 days overdue on your payment. At this point, your loan balance becomes fully due for federal student loans. Private student loans typically go into default status when you are at least 120 days overdue on your payment. When you are in default, you will likely be faced with collection activity and you may be sued to collect the debt.
A default stays on your credit report for up to seven years from the date of the first default. Search for Brookings Institution estimates that around 40% of student loan borrowers will be in default by 2023.
There is good news for federal student loan borrowers, however. There is an option to remove the default from your credit history.
“If the borrower defaults on the federal student loan, he has a unique opportunity to rehabilitate his debt. This will remove the default from his credit history, ”says Kantrowitz. In order to rehabilitate a delinquent student loan, you must establish a revised payment with your loan manager and make nine payments within 10 months.
However, allowing your loan to reach default status can hurt your credit even if you undergo loan rehabilitation. Even if the default status is removed from your credit history, loan pardon does not remove the history of late payments leading to default.
Debt-to-income ratio. Another factor that affects your credit is the amount of debt you owe, which is 30% of your score. Revolving credit, like a credit card, is used to determine your use of credit and its impact on your credit. However, too much installment debt, such as student loan debt, could also affect your ability to borrow.
This is because it could increase your debt-to-debt ratio, also known as DTI, which is a measure of your financial health and is often assessed by lenders to determine if you can afford to pay off a new loan. Your DTI is the amount of your gross monthly income that must be used to pay off debt. The more you have to repay each month, the higher your DTI. While your DTI does not affect your credit score, it does influence loan decisions.
However, Kantrowitz points out that federal student loans allow borrowers to enroll in income-based repayment plans if their payments are too high. “This bases the monthly payment on the borrower’s income, as opposed to the amount he owes. This can significantly reduce the debt-to-income ratio, thereby increasing the borrower’s eligibility for mortgages and other types of consumer credit, ”says Kantrowitz.
How to manage student loans like a pro
Now that you understand how student loans can affect your credit, be sure to follow a few guidelines to make sure your student debt only helps – and doesn’t hurt.
Borrow only what you need. It can be tempting to borrow extra money on a student loan to pay for non-educational expenses like dining out or paying for your car. But because excessive debt can make it harder to keep track of payments, it’s important to borrow only what you absolutely need to cover tuition. Just because you are offered a certain amount does not mean you should take it.
Pay every invoice on time and in full. Kantrowitz suggests putting a note in your calendar two weeks before your first loan payment is due. “The first payment is the payment most likely to miss,” he says. You can also check StudentLoans.gov and AnnualCreditReport.com to identify loans under your name that you may have overlooked. Once your loans are counted, sign up for automatic payments. “Not only are you less likely to be late with a payment, many lenders will give you a rebate as an incentive,” Kantrowitz says.
Let your lender know if you need help. If you’re having trouble making your payments on time, it’s important to contact your loan officer immediately. This can help you decide if repayment, deferral, forbearance, or other income-based repayment option is right for you. Don’t let your situation lead to late payments or defaults, as it is much more difficult to get back on track after this point.
Diploma. The thought of struggling with student loans and potentially facing a default can seem scary, but there are steps you can take to avoid this situation and keep your loans in good standing. One way is to make sure you graduate, giving you the best possible chance of finding a job that offers the income you need to pay off debt.
Consider alternatives. If student loan payments are too high for your budget, and options with your lender aren’t helpful enough, refinancing or forgiving a student loan can take some relief so you can stay up to date on payments. If you are eligible for student loan forgiveness, you can eliminate your student loan debt under certain programs. Student loan refinancing can reduce your monthly payments so that they are more affordable. However, refinancing can delay payments for a longer period of time, which increases your overall interest cost. And refinancing federal student loans into private loans means you will lose federal benefits.