Student record

How Student Loans Affect Your Credit

Student loans can have a major effect on your credit score, so it pays to understand the relationship between student loans and credit. On the one hand, borrowing and repaying student loans can do wonders for your credit history. On the other hand, a misstep like a missed payment can cause your score to drop.

Can student loans have a positive impact on your credit?

If you manage your student loans responsibly, they can help you build good credit. In fact, student loans can have a positive impact on three of the five factors that make up your credit score — payment history, length of history, and credit mix — according to Gregory Poulin, co-founder and CEO of the Administrator of Goodly Student Loan Repayment Benefits.

  • Create a positive payment history. The most important factor in your credit score is your payment history, which accounts for 35%. That’s why one of the best things you can do for your credit is to pay your student loan bill on time and in full each month.

    You can also improve your credit score by starting to pay off your student loan sooner than expected. Some lenders allow borrowers to make small payments — like a flat $25 a month or interest-only payments — during school deferment and the grace period after graduation, says Mark Kantrowitz, author of the book “How to Appeal for More College Aide” and expert in student loans. “These payments are flagged as actual payments on the borrower’s credit history, which has a positive impact if the borrower makes them on time.”

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  • Establish the term of the credit. Your credit history is a record of how long you have used credit, including how long various accounts have been open and active. It’s also a pretty big factor in your credit score, accounting for 15% of your FICO score.

    However, students may have little or no credit history because they are young and inexperienced in borrowing money. Fortunately, 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 credit, Kantrowitz says.

  • Create a mix. In addition to a long credit history, lenders like to see a diversified one. That’s why your credit mix, or types of credit used, make up an additional 10% of your FICO credit score, Poulin explains. Whether it’s car loans, credit cards, mortgages or student loans, the more types of credit you have on file, the better it is for your score. Plus, if you don’t have a long credit history, a good credit mix can have even more of an impact.

Does paying off student loans help your credit score?

Managing student loans responsibly and making payments on time has a positive impact on your score. So what about paying them back completely?

You might be surprised to find that your credit score drops a bit after paying off a loan. Once the account is closed and no longer active, positive payment history will not contribute significantly to your score. However, the impact of repaying a loan will be beneficial in the long run. It shows lenders that you’ve kept your end of the deal. Plus, you’ll have more disposable income to reduce other debts, which can improve your debt-to-income ratio. You should therefore see your credit score improve within a few months.

The same applies if part or all of your student loan balance is forgiven. However, there may be tax consequences for the year they are forgiven. Unpaid tax debt does not directly affect your credit score, but it can lead to financial complications.

You might have a similar experience if you refinance your student loan debt. In the short term, your credit rating could be affected, as a request for refinancing leads to a thorough investigation of your credit. As long as you only have one or two serious inquiries on your credit profile (which stay for two years), the impact on your score is minimal. And as long as you continue to make payments under the refinance’s new terms and eventually pay it back, the long-term benefits will outweigh the short-term drawbacks.

How Student Loan Debt Can Hurt Your Credit

While student loans can be good for your credit, it’s also easy to get into trouble. If you’re not careful with payments or take on too much debt, your credit score can suffer.

  • DTI. A measure of how much debt you owe is the debt-to-income ratio, or DTI, which is the percentage of your gross monthly income that must be allocated to paying off debt. The more you have to repay each month, the higher your DTI. Although the DTI is not used to calculate your credit score, lenders use it to make loan decisions. And required student loan payments can drive up your DTI.

    Kantrowitz notes 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 consumer credit,” says Kantrowitz.

  • Missed payments. It is important to avoid missing student loan payments. “Since payments make up 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 it is and how often you tend to miss payments. The later it is, the more harmful its impact. Even so, if you have a score of 780 and have never missed a payment before, a single payment 30 days late could drop your score by 90 to 110 points.
  • Co-signer credit. In addition to hurting your own credit score, Kantrowitz warns that missing payments will also negatively affect the credit of any co-signers on your loans. This is the case with private student loans, which require a credit check to qualify. A co-signer is sometimes necessary if the borrower does not have good credit. Co-signers take responsibility for repaying the debt if the original borrower cannot, and they suffer damage to their credit if payments are missed.

What happens if you don’t pay your student loans?

If you really let your student loan payments slip away, you could find yourself in default. It’s a much worse situation for your credit.

For most federal student loans, you are considered in default if you are at least 270 days past due. At this point, your entire loan balance becomes due in full for federal student loans. Private student loans usually go into default when you are at least 90 days behind on your payment. When you are in default, you will likely encounter collection activity and could 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.

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, they have a unique opportunity to rehabilitate the debt. This will remove the default from their credit history,” Kantrowitz explains. In order to rehabilitate a student loan in default, you must establish a revised payment with your loan servicer and make nine payments within 10 months.

However, allowing your loan to reach default status can hurt your credit even if you proceed with loan rehabilitation. Even with the default status removed from your credit history, loan rehabilitation does not remove the record of late payments leading to default.

Keep in mind that if your loans are deferred, such as during tuition 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 requirements.

How to handle student loans like a pro

Now that you understand how student loans can affect your credit, be sure to follow these guidelines to ensure your student loan debt is only helping you, not hurting you.

  • Borrow only what you need. It might be tempting to take out an extra student loan to pay for non-school expenses like restaurant meals or car payments. 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 tuition. Just because you’re offered a certain amount doesn’t mean you have to take it.
  • Pay every bill 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 be missed,” he says. You can also check StudentAid.gov and AnnualCreditReport.com to identify loans in your name that you may have overlooked. Once your loans are posted, 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,” 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. It can help you decide if income-based repayment, deferment, forbearance, or another alternative repayment option is right for you. Don’t let your situation get into late payments or default because it’s much harder to get back on track after that point.
  • Graduate. The thought of struggling with student loans and facing default may seem daunting, but there are steps you can take to avoid this situation and keep your loans in good standing. One way is to ensure you graduate, giving you the best chance of finding a job that provides the income you need to pay off debt.
  • Consider alternatives. If student loan payments are too high for your budget and the options with your lender aren’t helpful enough, refinancing or student loan forgiveness can provide relief so you can stay up to date on payments. If you qualify for student loan forgiveness, you can eliminate your student loan debt under certain programs. Student loan refinancing can lower your monthly payments so they are more affordable. However, refinancing can drag out payments over a longer period of time, increasing your overall interest costs. And refinancing federal student loans into private loans means you’ll lose federal benefits.