Student loans can have a major effect on your credit score, so it pays to understand the relationship between student loans and credit. On one hand, borrowing and paying back student loans can do wonders for your credit history. On the other, a misstep like a missed payment can send your score plummeting.
How Student Loans Can Positively Impact Your Credit
Think student loan debt is all bad? Not quite. If you manage your loans responsibly, they can help you build good credit. In fact, student loans can positively impact three of the five major factors that make up your credit score — payment history, length of history and credit mix — according to Gregory Poulin, co-founder and CEO of student loan repayment benefit administrator Goodly.
Positive payment history. The most heavily weighted factor in your credit score is your payment history, which makes up 35 percent of your overall FICO credit score. That’s why one of the best things you can do for your credit is pay your student loan bill on time and in full every month.
Even if your loans are in deferment, such as during the in-school and grace periods, the fact that you’re not currently making payments is neutral and won’t count against you. During these periods, you are still meeting the loan requirements.
But some lenders allow borrowers to make small payments — such as a flat $25 per month or interest-only payments — during in-school deferment and the grace period following graduation, says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com. “These payments get reported as real payments on the borrower’s credit history, having a positive impact if the borrower makes them on time.”
That means it can help your credit score if you make student loan payments, even if you don’t have to yet. Getting started early on paying back your loans means building a positive payment history — and good credit — that much sooner. Not to mention, you’ll knock off some of the accrued interest from your balance.
[Read: Best Private Student Loans.]
Credit history. Your credit history is a record of how long you’ve been using credit, including how long various accounts have been open and active. Lenders like to see that you have plenty of experience using credit, so the longer your credit history, the better. It’s also a fairly important factor in your credit score, accounting for 15 percent of your FICO score.
College students may have a thin or nonexistent credit history since they’re young and may not have had a chance to take out many credit cards or loans. And even though not all student loans require a credit check, they all show up on the credit file of the borrower. For a student with limited credit history, this can have a dramatic impact on their credit, says Kantrowitz.
By taking out student loans, you start your credit history earlier than if you waited until after graduation to borrow money. Though no one should go into debt just for the sake of their credit score, getting an early start on credit building is a nice perk of student loans.
Credit mix. In addition to a lengthy credit history, lenders like to see a diverse one. That’s why your credit mix, or types of credit used, makes up another 10 percent of your FICO credit score, says Poulin. Whether it’s auto loans, credit cards, mortgages or student loans, the more types of credit you have on your file, the better it is for your score. Plus, if you don’t have a long credit history, a good credit mix may be even more impactful.
How Student Loan Debt Can Harm Your Credit
Though student loans can be a good thing 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 as a result.
Missed payments. Remember how important payment history is for your credit score? The last thing you want to do is miss a payment. “Because payments comprise 35 percent of credit history, missing and late payments have a negative impact,” says Poulin.
The severity of a missed payment will depend on how late it is and how often you tend to miss payments. The later it is, the more detrimental its impact. Even so, just one payment that’s 30 days late could cause a drop of 90 to 110 points for someone with a score of 780 who has never missed a payment in the past. Further, Kantrowitz warns that missing payments will also negatively affect the credit of any co-signers on your loans.
Although deferment and forbearance do not have a negative effect on your payment history, any payments missed before implementing the plan are negative. If you’re struggling to make payments, talk to your student loan servicer before you miss one.
Default. If you really let your student loan payments slip, you could end up in default. That is a much worse situation for your credit.
For most federal student loans, your loan is considered to be in default if you are at least 270 days behind on payment. At that point, your entire loan balance becomes due in full for federal student loans. Private student loans typically fall into default status when you’re at least 120 days late on your payment. When you’re in default, you’ll likely face collection activity and may be sued to collect the debt.
A default stays on your credit report for up to seven years from the date of first delinquency. Research from the Brookings Institution estimates about 40 percent of student loan borrowers will default by 2023.
There is good news for federal student loan borrowers, however. There is an option for removing the default from your credit history.
“If the borrower defaults on the federal student loan, they have a one-time opportunity to rehabilitate the debt. This will remove the default from their credit history,” says Kantrowitz. In order to rehabilitate a defaulted student loan, you must work out a revised payment with your loan servicer and make nine payments within a period of 10 months.
However, allowing your loan to reach default status can harm your credit even if you do loan rehabilitation. Even with the default status removed from your credit history, loan rehabilitation does not remove the record of late payments leading up to the default.
Debt-to-income ratio. Another factor that affects your credit is the amount of debt you owe, which accounts for 30 percent of your score. Revolving credit, such as a credit card, is used to determine your overall credit utilization and its impact on your credit. However, too much installment debt, such as student loan debt, could adversely affect your ability to borrow, too.
That’s because it could increase your debt-to-income ratio, also known as DTI, which is a measure of your financial health and is often evaluated by lenders when determining if you can afford payments on a new loan. Your DTI is the amount of your monthly gross income that has to go toward debt repayment. The more you have to repay each month, the higher your DTI. Although your DTI does not affect your credit score, it does influence lending decisions.
However, Kantrowitz points out that federal student loans allow borrowers to enroll in income-driven repayment plans if their payments are too high. “This bases the monthly payment on the borrower’s income, as opposed to the amount they owe. This can significantly reduce the debt-to-income ratio, 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, make sure you follow a few guidelines to ensure your student loan debt only helps — not hurts.
Only borrow what you need. It might be tempting to borrow extra student loan money to pay for noneducational costs like dining out or your car payment. But since too much debt can make it harder to keep up with payments, it’s important to only borrow what you absolutely need to cover college costs. Just because you’re offered a certain amount doesn’t mean you need to take it.
Pay every bill on time and in full. Kantrowitz suggests putting a note in your calendar two weeks before the due date for your first loan payment. “The first payment is the payment that is most likely to be missed,” he says. You can also check StudentLoans.gov and AnnualCreditReport.com to identify any loans under your name that you may have overlooked. Once your loans are accounted for, sign up for automatic payments. “Not only are you less likely to be late with a payment, but many lenders will give you a discount as an incentive,” says Kantrowitz.
Let your lender know if you need help. If you struggle with making your payments on time, it’s important to contact your loan servicer right away. It can help you decide whether income-driven repayment, deferment, forbearance or some other alternative repayment option is right for you. Don’t let your situation get to the point of late payments or default, because it’s much tougher to get back on track after that point.
Graduate. The idea of struggling with student loans and potentially facing default might seem scary, but you can take steps to avoid that situation and keep your loans in good standing. One way is to ensure you graduate, giving yourself the best odds at finding a job that offers the income you need to pay back the debt.
Consider alternatives. If student loan payments are too much for your budget and options with your lender aren’t helpful enough, student loan refinancing or forgiveness may offer relief so you can stay current on payments. If you’re eligible for student loan forgiveness, you can eliminate your student loan debt under some programs. Student loan refinancing can lower your monthly payments so they’re more affordable. However, refinancing can drag out payments over a longer period, increasing your overall interest cost. And refinancing federal student loans into private ones means you’ll lose federal benefits.
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