How Student Loans Impact Your Credit Score

Navigating student loan debt can be challenging, but responsibly managing your student loans can actually benefit your credit score. Student loans can contribute to a strong credit history, provided you follow best practices in managing your repayments. If you've borrowed money to pay for your college education, you may ask, "Do student loans affect your credit score?" After all, credit is an important part of your life as a consumer. It impacts how likely you are to be approved when applying for a new credit card, financing a new car or getting a mortgage.

Understanding Your Credit Score

Before diving into the specifics of student loans, it’s essential to understand how your credit score works. A credit score is a number calculated based on information in your credit report. A FICO credit score ranges from 300 to 850, with 850 considered an excellent score. Various factors influence your credit score, including your payment history, credit utilization, length of credit history, credit mix, and new credit accounts.

Factors Influencing Credit Score

A credit score consists of five categories or sections:

Payment History (35%): This calculation relies on your on-time payments.
Amount of Debt Owed (30%): This compares your total available credit vs. how much of it you're using.
Length of Credit History (15%): The age of your credit accounts matters. The longer your loans stay open and in good standing, the better it is for your credit score.
Credit Mix (10%): Having both installment credit (loans) and revolving credit (credit cards) can boost your score by showing you can manage different types of credit. However, it’s crucial to not take on more debt than your future finances can handle.
New Credit Activity (10%): Be cautious about opening new credit accounts or taking on new debt.

The Positive Impact of Student Loans on Credit

While they can be imposing debts for those just starting out in their careers, student loans could offer an opportunity to build your credit history.

Building a Positive Payment History

Your payment history is the biggest factor in your credit score - it accounts for 35% of your FICO score. Student loans allow you to make positive payments. Payments against open loans or lines of credit are reported to the three main credit bureaus and become part of your credit report. When on-time payments land on your credit history, your credit score can grow. So when you make regular payments on your student loans, your credit score could improve. If you’re a recent graduate, student loan repayment can be crucial to your credit profile. When managed responsibly, it can contribute positively to your credit score.

Increasing Average Account Age

Student loans increase your average account age. Average account age, also known as the length of your credit history, accounts for a portion of your VantageScore® or FICO® score. When you have a long history of responsible credit use, you're seen as a lower risk to lenders than someone with a shorter credit history. Paying back your student loans over many years increases your average account age, helping you demonstrate financially responsible behavior. Long-standing accounts can positively contribute to your credit history length, which makes up 15% of your FICO score. A longer credit history can give lenders a better idea of how you’ve borrowed and repaid debt over the years.

Diversifying Credit Mix

Student loans expand your credit mix. Credit mix, or the different types of credit accounts you have, makes up 10% of your FICO score. If you have multiple kinds of credit in your name - one or more credit cards, a home loan, a personal loan, or student loans, for instance - you are seen as someone who can manage many different demands in your financial life. Managing various types of debt well, such as student loan and credit card debt, can show lenders you’re a reliable borrower. By reducing your perceived risk as a borrower, a better credit mix could help to increase your credit score.

Establishing Credit History

If you've never dealt with credit before, student loans can help you establish a credit history for the first time.

Potential Negative Impacts of Student Loans on Credit

Student loans can negatively impact your credit score if you fail to pay them off in a timely manner.

The Impact of Missed Payments

Late payments on any outstanding debt, including credit card balances or student loans, can negatively impact your credit score and stay on your credit report for up to seven years. Failing to make student loan payments may harm your credit. The influence of payment history on your credit score cuts both ways. While making regular debt and credit card payments may help boost your credit score, failing to make your scheduled payments can substantially lower your score. Just a single missed payment can damage your credit score significantly.

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Defaulting on Student Loans

Defaulting on your student loans has a major negative credit impact. From a credit score perspective, the only thing worse than missing a loan payment is defaulting on the loan entirely. Federal student loans move into default 270 days after the first missed payment. Other types of loans may even go into default sooner, so be sure to read your loan agreement to find out how many missed payments could lead to a default. As described by the Department of Education, the consequences of a student loan default are severe. Apart from significantly damaging your credit score, a defaulted loan could lead to having your wages and tax returns seized to pay off the loan, and a defaulted loan may persist for up to seven years on your credit report. Defaulting on federal student loans means that you've failed to make a payment for nine months-private lenders may start the process sooner.

High Loan Balances and Debt-to-Income Ratio

While student loans don’t affect your credit utilization like credit cards do, a large balance may impact your debt-to-income ratio (DTI), which lenders may consider when you apply for other types of credit. Your debt-to-income ratio (DTI)-the portion of your gross monthly income that goes toward debt payments-isn't part of your credit score.

Managing Student Loans Responsibly to Build Credit

Staying on top of your student loan payments can help improve your credit score, but if the payments become difficult to fit into your monthly budget, it’s worth exploring what options you have to make repayment more manageable.

Strategies for Responsible Management

Make regular payments: Whichever version of your credit score you are looking at, your track record of making payments is highly influential. It's simple: making regular payments on your loans and credit cards could boost your score. Failing to pay what you owe may hurt your score.
Set up automatic payments: Setting up automatic payments or reminders can ensure your bills are paid on time each month. This helps you avoid late fees and build your credit score with a positive payment history. Auto pay ensures you never miss a due date. Some loan servicers even offer an interest rate discount when you enroll in auto pay. Once you're in repayment, set up autopay on your loans to ensure that you never miss a payment.
Consider an income-driven repayment plan: If you have federal student loans and your payments are too high, consider getting on an income-driven repayment plan. Through an IDR plan, you could reduce your monthly payment amount based on your discretionary income. A lower monthly student loan payment can mean being able to better manage other types of debt, leading to an improved credit score. These plans also offer eventual forgiveness on your remaining debt after a determined period of repayment.
Communicate with your loan servicer: If you're struggling to make your payments, contact your lender. You may be able to defer your payments, negotiate a repayment plan based on your income or consolidate your loans under a single interest rate. If you’re having trouble making payments, don’t ignore it. Reach out to discuss alternate repayment options or ways you may be able to postpone your loan payments for a period of time. It’s a tough conversation but one that can save you a lot of trouble down the line.
Explore relief options: If you're experiencing financial hardship due to a job loss, death in the family, medical bills or any other reason, you may qualify for deferment or forbearance on your loans.
Consider making small payments while in school: Your loan servicer or lender will typically allow you to make payments during your in-school deferment.

Additional Tips for Protecting Your Credit

Review your credit report regularly: Review your credit report regularly for inaccuracies. You can get a free credit report from each of the three bureaus once a year at AnnualCreditReport.com. It’s a good habit to check for errors or signs of identity theft.
Avoid default: Explore all your repayment options and stay proactive. Default can be avoided if you act early and ask for help.
Catch up on late payments quickly: If you miss a payment by just a day or two, you may be on the hook for a late fee. However, you don't have to worry about it damaging your credit until it's 90 days late for federal loans or 30 days for private loans.

Understanding Student Loan Repayment Options

To avoid being late, missing payments or defaulting, take a look at your repayment plan. Make sure it's a good fit for your situation and that you can keep up with the payments. You can change your repayment plan for federal loans at any time at no cost. You'll just need to reach out to your loan servicer to discuss your repayment plan options to determine which one works best for you.

Deferment vs. Forbearance

Both options protect you from missed payments and can prevent long-term damage to your credit. Loans are often deferred while you’re enrolled in school. As long as your loans are in good standing, deferment doesn’t hurt your credit. After graduation, or dropping below half-time status, you typically have a six-month grace period before repayment begins. Use this time to plan your budget and prepare for payments-your credit depends on it. If you’re struggling to make payments due to hardship, you may qualify for forbearance or deferment. These options pause your payments without hurting your credit, but interest may still accrue.

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Consolidation

Consolidating your loans can make repayment easier, but it may close older accounts and affect the average age of your credit, which could temporarily impact your score.

Refinancing

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 or length of time you have to pay the loan. Over time, it could save you quite a bit of interest. It could also lower your monthly payment amount while lengthening your repayment 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.

Alternatives to Build Credit

Whether or not you're using student loans to help pay for school, there are several ways you can build credit from scratch.

Become an authorized user: When someone (often a parent) adds you as an authorized user to one of their credit cards, the card account's history may be reported to the credit bureaus under your name as well.
Open a student credit card: Some credit card issuers offer student credit cards, which tend to have easier qualification requirements than traditional cards.
Consider a secured credit card: If you can't qualify for a student credit card, a secured credit card could be a solid alternative. These cards don't require you to be a college student, but you will need to provide a refundable security deposit-usually $200 or more-to get approved.
Get a cosigner: If you need to borrow money for another reason, such as buying a car, consider asking a parent or other loved one with good credit to cosign your loan application. This arrangement can improve your approval odds and even help you secure a lower interest rate, making your monthly payments more affordable.
Use Experian Boost®: Experian Boost is a free feature that allows you to add nontraditional payments, including rent, utilities, cellphone, insurance and even some streaming subscriptions, to your Experian credit file.
Add bank accounts to Experian Boost®: Add any bank accounts you use to pay your bills.

Paying Student Loans with a Credit Card: Weighing the Pros and Cons

If you pay your student loans with a credit card using an intermediary, there are some important factors to consider. Making student loan payments on a credit card can have negative consequences, so it's important to be aware of how this could affect your overall finances.

Potential Downsides

Increase your credit utilization ratio: This factor, which refers to the amount of your available credit that you use from month to month, represents about 20% of your credit score. The more you put on your card(s), the higher your utilization ratio, which can dent your score in the short term.
Accrue more interest if you carry a credit card balance: Credit cards can have much higher interest rates than student loans. If you don't pay your monthly card balance in full, you could accrue interest rapidly - and even begin paying interest on the accrued interest.
Limit flexibility for other spending needs: One of the primary benefits of a credit card - the ability to make large purchases - is reduced if you put hundreds or thousands of dollars of monthly student loan payments on your card.
Spend more overall: Even if you do everything else right, you may still have to pay fees to your lender for using a credit card. If this fee exceeds the rewards you get on your card, you'll end up losing money.

Potential Benefits

Enhance your payment history: If you make timely student loan payments with a credit card then pay off the card balance on time, you can get more positive payments on your credit history.
Diversify your credit mix: A mix of loan types and credit is better for your credit score than a more homogenous borrowing portfolio.
Potentially gain rewards through your credit card: If you have a rewards credit card, you may accrue rewards by adding student loan payments to your card balance. Be sure to verify with your credit card provider to make sure if you do pay off your student loans via the credit card, you earn points for this expense.

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