When most 18-year-old college freshmen sign on the dotted line to take out private student loans, they’re not thinking about credit scores. They’re thinking about class schedules, life goals and avoiding the infamous “freshman fifteen.”
But the truth is that student loans can (and do) impact your credit scores from the very moment you take them out. Whether you’re a brand new college student who hasn’t even started repaying student loans yet or a 30-something still struggling to pay back that debt and considering refinancing, you need to understand how student loans can impact your credit scores and your ability to borrow. (You can see how your student loans may be affecting your credit by viewing two of your credit scores, updated every 14 days, on Credit.com.)
1. They’ll likely open your credit file
Most straight-from-high-school college freshmen don’t have a credit file to speak of before taking out student loans. But because the federal government doesn’t require good credit for most types of student loans, that doesn’t matter. As soon as you take out a loan, you’ll have a credit file opened, likely with all three major credit reporting bureaus. This is the start of your credit history and subsequent numerical credit scores.
2. They can help establish a longer credit history
One portion of your credit scores comes from the length of your credit history. The longer you’ve had credit, the higher your score will be. For many students, student loans are their first piece of credit. And because they’re likely to stick around on your credit reports for ten years or more while you’re in repayment, student loans can give your score an automatic lift.
3. On-time payments can keep your score growing
On-time payments are the most heavily-weighted portion of the credit score algorithm. After all, lenders want to be sure you’ll repay your loans on time each month. Paying your student loans on time from the time you enter into repayment can keep your credit scores growing, slowly but steadily.
One thing to note here is that if you have to put your loans into deferment or forbearance due to financial hardship, this shouldn’t harm your credit scores. Call the lender as soon as you know you’ll be unable to keep making payments. They can put the loan into forbearance, which will stop payments for a while. This doesn’t get you out of repaying the loan, of course, but it will save you from late payment reports on your credit scores.
4. Missed payments can quickly tank it
Steadily repaying your loan with on-time payments will increase your scores, but slowly. On the flip side, missing payments can tank it, and quickly. However, most federal student loan servicers won’t report a payment as late until it’s been 60 days late by the end of the month. So you often have more grace with these loans than other types. Still, it’s best to get into the habit early on of making on-time payments each and every month.
5. They can help you add variety to the mix
A few high school and college students have other debt coming into the student loan process. For instance, you might have a low-limit credit card on your report already. If this is the case, adding student loans as an installment loan can add variety to your credit file. Because variety is one thing lenders look for, this can also help boost your credit scores.
6. Resolving delinquency can immediately increase your score
Resolving delinquency on other types of loans isn’t always easy, and the delinquency reports may take months or even years to recover from. This isn’t always the case with student loans. If you lose your job, for instance, and miss three months’ worth of payments, your score will quickly fall. But if you later work out with your lender to back-date the deferment of your loan, they can forgive those late payments, effectively erasing them from your credit scores.
It’s better to never become delinquent on your student loans, of course. But if you do, resolving the problem as quickly as possible can help you increase your credit scores almost immediately.
Your debt-to-income ratio can be important
It’s a common misconception that a person’s debt-to-income ratio — the amount of your minimum payments each month versus the amount of income you make— is a part of your credit scores. It’s actually not. Credit bureaus don’t know how much money you make, and they don’t really care. As long as you’re meeting your obligations each month and your credit utilization rate is in good shape, your credit scores should stay intact. (Note: Your credit utilization rate, also referred to as your credit-to-debt ratio, is essentially how much debt you’re carrying versus the amount of credit extended to you. For best credit scoring results, it’s generally recommended you keep the amount of debt you owe below at least 30 percent and ideally 10 percent of your total available credit limit.)
Lenders, on the other hand, care about debt-to-income ratio very much. If 50 percent of your monthly income is eaten up by minimum debt payments, you’ll likely have trouble obtaining a mortgage.
So even though your minimum student loan payments in comparison to your monthly income don’t affect your credit scores, they can affect your ability to borrow. This is why it’s so important when taking out student loans to examine how much your chosen career is likely to earn you. Then, compare that to what you’re likely to pay in minimum student loan payments before you sign on the dotted line for that loan.