How Student Loans Can Impact Your Credit Score

It’s no secret that a college education is expensive. Student loans are often a necessary step toward funding that education for millions of borrowers. Like all debt, student loans are a serious financial commitment - one that could have a long-term impact on your credit scores, both positively and negatively. Navigating student loan debt can be challenging, but responsibly managing your student loans can actually benefit your credit score - not hurt it.

Understanding Student Loans

Student loans can be offered as a part of a larger financial aid package that may also include scholarships, grants and other kinds of funding. Government and private financial institutions both offer student loans, although federal options often have more favorable terms.

Here are some common types of federal student loans:

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

How Credit Scores Work

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.

Here's a breakdown of the main components of a credit score:

Payment History (35%): Your payment history indicates if you make your payments on time. This is the biggest factor in your credit score.
Amount of Debt Owed (30%): This portion of your score is based on how much available credit you're using. This is also known as your credit utilization ratio.
Length of Credit History (15%): This factor looks at the age of credit in your account. Creditors want to see a long history of responsible credit use.
Credit Mix (10%): Creditors like to see that you can manage a mix of different types of credit, including credit cards, installment loans, and more.
New Credit (10%): When you apply for new credit, it’s considered a hard inquiry on your credit history.

The Positive Impacts of Student Loans on Credit

Student loans can contribute to a strong credit history, provided you follow best practices in managing your repayments. Here's how:

Establishing Credit History: For many young people, student loans are unavoidable and offer an opportunity to build your credit history. You can help your credit history by taking on a student loan early in your credit journey.
Payment History: 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. Making consistent, on-time payments is one of the best ways to build your credit.
Credit Mix: A student loan is a type of installment loan, which is simply a loan you repay over time with scheduled payments (like a mortgage or car loan). Managing various types of debt well, such as student loan and credit card debt, can show lenders you’re a reliable borrower. Your student loan can also help to diversify your credit. This shows lenders that you can manage different types of accounts.
Length of Credit History: You can add to your length of credit history by taking on a student loan. This is because it usually takes a long time to pay off. The longer your loans stay open and in good standing, the better it is for your credit score.

The 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. Here's how:

Payment History: 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. Even a single missed payment can significantly decrease your score, and any negative payments could stay on your credit report for up to seven years.
Delinquency and Default: If you miss a payment, you have 90 days before the loan is considered delinquent. If you continue to miss payments, you run the risk of the loan going into default, which can further decrease your credit scores. Delinquency or default can remain on your credit reports for up to seven years. From a credit score perspective, the only thing worse than missing a loan payment is defaulting on the loan entirely.
High Loan Balances: 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.

Managing Student Loans for a Better Credit Score

Staying on top of your student loan payments can help improve your credit score. Here are some tips for protecting your credit while managing loans:

Make Payments During Your Grace Period: Even during school or grace periods, if payments are required (like with some private loans), be sure not to miss them.
Pay More Than the Minimum: If you can, paying more than the minimum due each month can help you pay off your loan faster and save on interest.
Consider Enrolling in Autopay: Your loans may offer the option of making monthly payments automatically, which helps ensure you’re paying on time. Auto pay ensures you never miss a due date. Some loan servicers even offer an interest rate discount when you enroll in auto pay.
Be Aware of Your Repayment Options: If you can’t make a payment, contact your lender immediately.
Communicate with Your Loan Servicer: 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 Income-Driven Repayment (IDR) Plans: If the payments become difficult to fit into your monthly budget, it’s worth exploring what options you have to make repayment more manageable. Through an IDR plan, you could reduce your monthly payment amount based on your discretionary income. These plans also offer eventual forgiveness on your remaining debt after a determined period of repayment.
Monitor Your Credit Regularly: 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.
Set up automatic payments or reminders: 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.

Student Loans and Credit Inquiries

First, lenders often perform what’s known as a credit check or a hard inquiry 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.

Hard Inquiry: A hard inquiry can affect your credit score for up to a year and appear on your credit report for up to two years. A flurry of credit applications in a short period can also signal that you’re taking on more debt than you can handle, making you riskier to lenders.
Soft Credit Check: By being deliberate about new credit applications, you can protect your credit score from unnecessary drops.

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 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.

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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.

If you’re trying to decide whether to refinance, weigh the trade-off between potentially affecting your credit score versus saving money with a loan that offers a lower interest rate. To refinance, you may need to shop around to find the best interest rate and terms on other loans, which could mean applying for a few. This can result in hard inquiries. If you refinance, it can also impact the length of your credit history. This is because the new loan pays off the original loan.

Forgiveness of Federal Student Loans

Forgiveness of federal student loans can also affect your credit score. Forgiveness is when your federal loan servicer will write off your remaining debt and you don’t have to repay. Creditors like to see that a borrower has a mix of installment and revolving credit. If a credit bureau removes your student loan from your credit history and you only have a credit card remaining, this could result in a slight and short-term impact on your credit score.

Paying Student Loans with a Credit Card

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.

You may:

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Increase Your Credit Utilization Ratio: 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.

When you make student loan payments with a credit card, you may:

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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