How Student Loans Affect Your Credit | Student Loans and Advice

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.

Can Student Loans Positively Impact Your Credit?

If you manage your student loans responsibly, they can help you build good credit. In fact, student loans can positively impact 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 student loan repayment benefit administrator Goodly.

  • Build positive payment history. The most heavily weighted factor in your credit score is your payment history, which makes up 35%. 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.

    You can also help your credit score by starting student loan repayment ahead of schedule. 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, author of the book, “How to Appeal for More College Aid” and student loan expert. “These payments get reported as real payments on the borrower’s credit history, having a positive impact if the borrower makes them on time.”

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  • Establish credit length. Your credit history is a record of how long you’ve been using credit, including how long various accounts have been open and active. It’s also a fairly important factor in your credit score, accounting for 15% of your FICO score.

    However, college students may have a thin or nonexistent credit history since they’re young and inexperienced with borrowing money. Fortunately, 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 credit, says Kantrowitz.

  • Create 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% 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.

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 off 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, the positive payment history won’t contribute to your score as significantly. However, the impact of paying off a loan will be beneficial in the long run. It shows lenders that you held up your end of the agreement. Plus, you’ll have more income available to put toward reducing other debts, which can help your debt-to-income ratio. So you should see your credit score improve in a couple of months.

The same is true if some or all of your student loan balance is forgiven. However, there may be tax consequences for the year they are forgiven. Unpaid tax debt doesn’t impact your credit score directly, but it can lead to financial complications.

You could have a similar experience if you refinance your student loan debt. In the short term, you might receive a ding to your credit score because applying for refinancing results in a hard inquiry of your credit. As long as you only have one or two hard inquiries on your credit profile (which stay for two years), the impact on your score is minimal. And as long as you continue making payments according to the new terms of the refinance and eventually pay it off, the long-term benefits will outweigh the short-term drawbacks.

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.

  • DTI. One measure of the amount of debt you owe is debt-to-income ratio, or DTI, which is the percentage of your monthly gross income that has to go toward debt repayment. The more you have to repay each month, the higher your DTI. Though DTI isn’t used in calculating your credit score, lenders use it in making decisions on loans. 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 of consumer credit,” says Kantrowitz.

  • Missed payments. It’s important to avoid missing student loan payments. “Because payments comprise 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 detrimental its impact. Even so, if you have a 780 score and had never missed a payment before, just one payment that’s 30 days late could drop your score by 90 to 110 points.
  • Co-signer credit. In addition to harming 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 for private student loans, which require a credit check to qualify. A co-signer is sometimes needed if the borrower doesn’t have good credit. Co-signers assume responsibility for paying back the debt if the original borrower can’t, and they suffer damage to their credit if payments are missed.

What Happens If You Don’t Pay Student Loans?

If you really let your student loan payments slip, you could end up in default. This is a much worse situation for your credit.

For most federal student loans, you are 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 when you’re at least 90 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.

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 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.

Keep in mind that 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.

How to Manage Student Loans Like a Pro

Now that you understand how student loans can affect your credit, make sure you follow these 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 and 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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