If you took out student loans to finance your college education, you may be wondering how they will affect your credit score. After all, credit plays a major role in your ability to get approved for loans and the terms and conditions you’ll receive, whether you are applying for a credit card, financing a new car, taking out a mortgage, etc.
Depending on how you manage your student loans, they can impact your credit scores both positively and negatively. The good news is that if you understand how they can affect your credit, you can take preventative measures to avoid potential pitfalls. Here’s what you need to know about how student loans impact your credit, how your credit score gets calculated, and ways to boost your credit.
Key Takeaways
- Student loans can affect your credit score in different ways.
- If you are having trouble repaying your federal or private student loans, talk to your lenders to discuss alternatives.
Types of Student Loans and How They Affect Your Credit Score
Yes, student loans affect your credit score. That is because student loans are a type of installment loan, similar to an auto loan or mortgage. Your student loans get reported to the three major bureaus (Experian, Equifax, and TransUnion) and will appear on your credit report. Credit-scoring companies like FICO® and VantageScore® use your credit reports and scoring models to calculate your credit score.
Types of Student Loans
There are several types of student loans available. Understanding the differences between various types of loans before borrowing money is crucial as they come with distinct terms and conditions.
The Stafford Loan is one of the most common student loans available. It is a federally subsidized loan, offering fixed, low interest rates and flexible repayment options. Borrowers can choose from several repayment plans, including deferred payment and income-based repayment plans. Stafford Loans do not require a credit check, making them an attractive option for students who do not have an established a credit history yet.
Banks and other financial institutions offer private loans, which typically have higher interest rates than federal loans but may have more flexible repayment plans. Private lenders may allow you to defer payments if you cannot find employment after graduation or if you return to school later on. Be sure to shop around because there can be significant differences in terms and fees among lenders.
Late or Missed Payments
Unfortunately, when you miss a payment or make a late payment, you will get penalized. One of the most immediate consequences is that you will get charged a late fee, which is usually around $30, depending on the lender.
Another repercussion of not paying your student loan debt is that your credit score may drop if your lender reports your late payment to one or all of the three major credit bureaus. That will stay on your credit reports for up to 7 years. According to the Department of Education, if you have a federal student loan, late payments will get reported to credit bureaus after 90 days. For private loans, lenders can report them at 30 days late.
The more overdue your payments are, the bigger the hit on your credit, especially if your loan goes into default. That could make it harder to borrow money in the future or even get a job. A lower credit score can also lead to increased interest rates, meaning you will end up paying more money in the long run.
Being delinquent or defaulting on your student loan payments has other ramifications as well. The lenders may send debt collectors after you, which can result in wage garnishment or even legal action taken against you.
How to Avoid Student Loan Default or Delinquency
If you are struggling with your loan payments, ask your lender if you can revise your loan terms. Usually, you will have a few options to choose from, and your credit score will not get impacted if you handle payments as agreed.
Income-Driven Repayment Plan
If you have federal student loans, you may be able to enroll in an Income-Driven Repayment Plan (IDR) to manage your debt. IDRs cap your monthly payments at a percentage of your income (typically 10-20% of your discretionary income) and often forgive the remaining balance after 20 or 25 years.
There are four different types of Income-Driven Repayment Plans: Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR). Each plan has its own requirements, so do your research and find the plan that best fits your situation. To check your eligibility, visit StudentAid.gov/idr. Enrolling is free and you can always change plans if your circumstances change.
Student Loan Forbearance
Student loan deferment and forbearance allows you to temporarily postpone your student loan payments without impacting your credit score. There are different types of student loan deferment available depending on your circumstances.
You may be able to get a deferment if you are unemployed, in school or serving in the military, experiencing economic hardship, or have certain medical conditions. Forbearances are also available for various reasons, such as unemployment or illness. Note that you will likely need to provide documentation stating you cannot make your current payments.
Additionally, interest will continue to accrue during both types of relief and can increase your balance and monthly payments after the deferment or forbearance period is over. Not all loans offer deferment and forbearance options — private loans typically do not have these benefits. If you have private loans, contact the lender directly to see if they offer any relief programs.
Student Loan Forgiveness
Student loan forgiveness reduces how much you owe, meaning you will not need to pay back some or all of your loan. However, there are specific criteria you need to meet to qualify, such as public service, teaching, and various other programs.
For example, if you work for the government or a non-profit, you may qualify for forgiveness of the remaining balance of your Direct Loans after making 10 years of payments via the Public Service Loan Forgiveness (PSLF). Or, if you teach full-time for 5 years in certain low-income schools, you may be eligible for forgiveness of up to $17,00 on your federal student loans via the Teacher Loan Forgiveness.
Federal Direct Consolidation Loan
A federal direct consolidation loan simplifies your student loan payments. When you consolidate your loans, you combine all of your existing loans into a new loan with a new interest rate and repayment term. You can choose to have the same monthly payment or a lower monthly payment by extending the repayment term up to 30 years.
Some benefits of consolidating your student loans include:
- One monthly payment instead of multiple payments
- A single lender which makes it easy to keep track of your account
- A lower interest rate could save you money over time
- The ability to extend the repayment term if needed could make it more manageable for you
However, keep in mind you may end up paying more interest over time if you extend the repayment term.
Student Loan Refinancing
With student loan refinancing, you work with a new lender to take out a new private student loan that pays off your old debt. Depending on your credit, this new loan may come with lower interest rates, saving you money on your monthly payments and overall interest paid. It can also simplify your debt by consolidating multiple loans into one payment.
However, refinancing is not for everyone. If you refinance your federal loans to a private loan, you will no longer be able to tap into the benefits of federal loan programs, such as income-driven repayment or loan forgiveness.
If you decide that refinancing is right for you, make sure you will qualify for the best interest rate possible and are comfortable with the new loan terms. There may be fees associated with refinancing, so calculate the costs before making a decision.
Shop around to find the best deal for your needs. Make sure to apply for all the loans you are comparing within a 14-day window so that you do not end up having multiple hard inquiries on your credit reports. Alternatively, you can get rate estimates through lenders’ pre-qualification processes.
How Student Loans Can Improve Your Credit
By taking out a student loan and making regular, on-time payments, you can show lenders you are responsible with money and can be trusted to repay debts. That will help improve your credit rating and make it easier for you to get approved for future loans or lines of credit.
If you have only used one type of credit before, such as a credit card, having a student loan can boost your score because it increases your credit mix. And if you take out student loans early on, it increases the amount of time you have had credit, which increases the average age of your credit history.
How Your Credit Score Gets Calculated
Credit scores range from 300 to 850. The higher your score, the better your credit rating, and the more likely you are to be approved for a loan or receive a low-interest rate. Your credit score consists of 5 categories:
Payment History
A good payment history means you always make your payments on time and keep your balance low. All of these things contribute to a high credit score. If you have a poor payment history — for example, if you have missed payments or had debts go into collections — then your credit score will be lower.
Credit Utilization
Your credit utilization is how much of your total available credit you use at any given time. Ideally, you want to keep your credit utilization below 30%. That means if you have a total limit of $10,000 across all of your cards, you do not want to use more than $3,000 at any given time. If you go over this threshold, it can negatively impact your credit score. Generally, I keep my utilization below 15% across all my credit cards.
Length of Credit History
The longer your credit history, the more reliable you will appear to lenders. That means you have had time to establish a good payment history and prove that you can handle debt responsibly.
New Credit
When you apply for multiple new lines of credit in a short period, such as applying for several credit cards simultaneously, that is a red flag for lenders. If you suddenly take on a lot of new debt, it will look risky to lenders and could lower your score because you may be more likely to miss payments.
Credit Mix
Your credit mix measures how well you’ve managed different types of debt. For example, if you have both installment loans and revolving loans, it shows that you can handle both short-term and long-term borrowing. A good credit mix usually means a better credit score.
The Bottom Line
Your credit mix measures how well you’ve managed different types of debt. For example, if you have both installment loans and revolving loans, it shows that you can handle both short-term and long-term borrowing. A good credit mix usually means a better credit score.
