Navigating Student Loans: Understanding the Impact on Your Credit Score

Building and maintaining good credit is a crucial lifelong financial skill. Student loans play a significant role in this process, affecting your credit score in both positive and negative ways. This article explores how student loans influence your credit score, providing insights for both current and prospective borrowers.

The Dual Nature of Student Loans and Credit

Undergraduate student loans are one avenue for building your credit history. Consistent, on-time payments demonstrate financial responsibility and can positively impact your credit score. Conversely, missed payments and delinquency signal higher risk to lenders, negatively affecting your creditworthiness.

As a graduate student, managing both federal and private undergraduate loans requires diligence. Maintaining current payments is essential, as private graduate student loans are credit-based, making your credit history a key factor in loan eligibility.

Pandemic Forbearance and its Impact on Credit Scores

The pandemic forbearance on federal student loans significantly impacted borrowers' credit scores. An 11-point increase in median credit scores for student loan borrowers occurred from the end of 2019 to the end of 2020. This increase was particularly pronounced for borrowers with prior delinquencies. The 2020 forbearance marked all delinquent (but not defaulted) loans as current, resulting in a 74-point jump in the median score for previously delinquent borrowers. Defaulted borrowers also saw a gradual rise in credit scores as negative marks aged and some voluntarily rehabilitated their loans.

In the fourth quarter of 2022, the Fresh Start program further boosted credit scores by marking all defaulted loans as current, increasing the median score for those with a default in 2019 by 44 points. By the end of 2024, borrowers with loans in delinquency or default saw scores that were significantly higher than at the end of 2019.

The Return of Negative Reporting and Potential Delinquencies

Delinquencies will appear on credit reports over time as borrowers miss payments and advance beyond 90 days past due. The delinquency rate for student loans is expected to increase significantly. A "shadow delinquency rate" is estimated by combining the total volume of non-federally owned loans that were 30 or more days past due with the total volume of loans 30 or more days delinquent from Federal Student Aid (FSA). Additionally, federal student loans serviced by the defaulted loan servicer are flagged as past due beginning when payments resumed.

Prior to the pandemic forbearance, the shadow delinquency rate reached a high of 14.8 percent. The delinquency rate fell at the start of the pandemic as loans were cured and due to the Fresh Start program. However, the scale of past due loans may have shifted. Borrowers who were past due could have cured their loans, and other borrowers have likely since fallen delinquent. Court cases affecting Income-Driven Repayment (IDR) plan applications and the SAVE Plan also influence payment status.

It is reasonable to expect student loan delinquency to surpass pre-pandemic levels when new delinquencies hit credit reports. While some borrowers may cure their delinquencies or enter administrative forbearance, the damage to their credit standing will remain on their credit reports for seven years.

Estimating the Impact of New Delinquencies on Credit Scores

Data from 2016 to 2019 estimates the credit score impact of a new reporting of a 90 (or more) days past due student loan delinquency by borrower credit score band prior to the delinquency. The average credit score change associated with a new student loan delinquency varies depending on the borrower's initial credit score.

Given these estimates, a significant number of student loan borrowers may face substantial declines in credit standing. The aggregate impact on overall credit access will depend on the previous credit standing of those with past due loans. If missed payments come largely from those with lower scores, the aggregate impact will be smaller. However, if prime and superprime borrowers fell behind on student loan payments, the aggregate drop in credit standing among student loan borrowers could be much larger, resulting in reduced credit limits, higher interest rates for new loans, and overall lower credit access.

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Understanding Student Loan Types and Their Impact on Credit

Student loans are often part of a larger financial aid package that may include scholarships, grants, and other funding. Private financial institutions also offer student loans, although these often have less favorable terms than federal options.

Direct Subsidized Loans: Available to students who can demonstrate financial need. The government pays the interest on these loans during a predetermined grace period.
Direct Unsubsidized Loans: Available to all students regardless of need. The student is generally responsible for paying interest throughout the life of the loan.
Direct PLUS Loans: Made available to the parents of dependent students and to students pursuing graduate or professional degrees.

Lenders perform a credit check to review your credit reports and determine if you’re a suitable candidate for a loan. Both Direct Subsidized Loans and Direct Unsubsidized Loans are offered to students regardless of their credit history and neither will result in a hard inquiry.

Building Credit with Student Loans

Taking out a student loan can potentially increase your credit scores by diversifying your credit mix. However, it’s important not to take on too much debt. Your payment history makes up the largest portion of your credit scores. If you make your required student loan payments on time and avoid going into default, your student loans may help you establish or build your credit history.

If you miss a payment, you have 90 days before the loan is considered delinquent. Delinquency or default can remain on your credit reports for up to seven years, negatively impacting your creditworthiness.

Managing Student Loan Repayment

If you’re struggling to meet your federal loan obligations, research options for repayment aid. For example, you might be eligible for lower monthly payments through an income-driven repayment (IDR) plan.

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Make payments during your grace period.
Pay more than the minimum.
Consider enrolling in autopay.
Be aware of your repayment options.
If you can’t make a payment, contact your lender immediately.

The Nuances of Paying Off Student Loans

Paying off your student loans can be a major accomplishment, but it might lead to a slight drop in your credit score. If the student loan was your only installment account, closing the account could decrease your credit mix. However, paying off the loan could still improve your creditworthiness.

Strategies for Maintaining Good Credit

Your credit could depend on more than your student loans, especially if you have other loans and use credit cards.

Pay your bills on time.
Open a credit card.
Only use a small portion of your credit limit.
Add additional payments to your credit report.

The Information in Your Credit Report

Your credit reports will contain information about your student loans, including:

Amount owed
Payment history
Length of credit history
Mix of credit types

Paying your student loans on time can help you build credit and maintain a positive credit score. In contrast, failure to make payments will hurt your score. Establishing a good credit history and credit score affects your future ability to take out loans and use credit at lower interest rates.

If you think you may not be able to make your student loan payments, contact your servicer to find out more options.

Credit Inquiries and Rate Shopping

Both large and small lenders often use credit scores to help them underwrite student loans. In general, student loan shopping inquiries made during a focused time period will have little to no impact on your score.

As you're shopping for the best student loan rate, the lenders you approach may request your credit report or credit score. You can generally avoid having those inquiries affect your score if you finish your rate shopping in a reasonable amount of time. Try to finish your rate shopping and finalize your loan within 30 days.

Credit Score Components

A credit score is a number calculated based on information in your credit report. It consists of five categories:

Payment history
Amounts owed
Length of credit history
Credit mix
New credit

Student loans are a type of installment loan, similar to a car loan, personal loan, or mortgage. They are part of your credit report and can impact your payment history, length of your credit history, and credit mix.

Avoiding Late Payments and Default

To avoid being late, missing payments, or defaulting, take a look at your repayment plan. You can change your repayment plan for federal loans at any time at no cost. A credit inquiry is a request to look at your credit file, which can result in either a hard or soft credit pull. Hard inquiries are the only credit pulls that can have a negative impact on your credit score and usually stay on your credit report for up to two years.

For instance, loans under the Federal Direct Loan Program or Federal Family Education Loan Program are considered in default if payments are missed after 270 days. Defaulting on a student loan may result in withheld wages and no further access to federal aid until the debt is settled or a repayment plan has been approved.

Refinancing Student Loans

When you refinance your student loans, a lender will pay off your debt and issue a new private student loan. This new loan may come with a lower interest rate or a different term. While refinancing can save you money, it can also pose downsides. When you refinance your federal loans to a private student loan, you can no longer tap any of the benefits that come with the federal program, such as income-driven repayment, loan forgiveness, forbearance, or deferment.

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