First: A Definition of “Credit Score”
As you probably know, your credit score is the result of a complicated calculation. To get your credit score, the credit bureaus inspect five different areas of your financial situation including:
HISTORY: Do you pay your bills on time, are you always late, never late, etc.
DEBT: How much money do you owe? More importantly, the credit bureaus want to know how much of your available credit you are using.
LENGTH: Length refers to how long you’ve had credit (and the average age of your open credit accounts).
NEW CREDIT: Are you aggressively pursuing new credit cards?
TYPE OF CREDIT: The credit bureaus want to know how much installment debt you have versus how much revolving debt.
The credit bureaus collect all of these factors and feed them into an algorithm. The resulting number is your credit score. Keep this in mind though: the credit bureaus are trying to assess your credit risk. They only want to determine as accurately as they can if you will or will not pay off a loan.
So, back to our question: does student loan debt hurt your credit score?
The answer is: “it depends.” Student loan debt in and of itself will usually not harm your credit score. However, if you have trouble paying your student loans, then your credit score could suffer.
It’s helpful to consider asking the question another way. What if you instead asked: “How does student loan debt look on my credit report?” Asking the question this way may help you understand your credit score from the other side.
When you look at it from the perspective of a potential lender trying to determine if you are a good credit risk (or not), then you’ll begin to see how student loans can affect your credit score. Remember, your student loans are a real debt, and like any other debt they will be reported regularly to the credit bureaus.
Installment Loans vs. Revolving Loans
From the perspective of the credit bureau your student loan is considered an installment loan. An installment loan is a debt that is repaid over time with a specific number of payments agreed on ahead of time by the lender and the borrower. You may be surprised to learn that installment loans with a very large balance are usually not considered as bad as a large revolving loan balance. For example, your student loan debt of $21,975 may have less impact on your credit score than your $3,900 Visa card balance.
Also, it is important to understand how your student loans are reported. Student loans are reported to the credit bureaus on a disbursement basis. This means each student loan that is disbursed to you is reported separately to the credit bureaus. For example, you may have a subsidized loan and a non-subsidized student loan. Each of these loans is reported as separate loans.
Student Loan Debt’s Affect on Your Credit Score
As mentioned above, there are several possible ways that student loan debt can impact your credit score. Student loans can hurt your credit score and in some cases they can actually help your credit score:
The Good: Interestingly, student loan debt can actually improve your credit score. Researchers have demonstrated that people can have high student loan debt and high credit scores. If you make your payments in full and on time, then your credit score can actually improve as these satisfactory payments are reported to the credit bureaus. Also, as you are making payments you are helping yourself establish a credit history.
The Bad: Alternatively, if you miss payments, don’t pay the full amount required, or worst of all, you default on your student loan, and then your credit score will be harmed. Additionally, unlike revolving debt, student loans cannot be discharged via a bankruptcy, except in extraordinary circumstances.
Conclusion: It’s important to be cautious and purposeful when taking out and repaying student loans. Student loan debt can absolutely hurt your credit score if your payment behavior indicates that you are not a good credit risk. But on the other hand it can be a positive influence on your credit score if you make the agreed-upon payments consistently and on time. In that sense, whether the student loan debt increases your credit score or decreases it is in large part completely up to you.
A note from Dominique: “If you liked this post, you can sign up for my credit newsletter. I send you weekly credit tips, tricks and hints to help you figure out your credit score and how to improve it.”
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