Does Student Loan Debt Hurt Your Credit Score?

Does student loan debt hurt your credit score?

Dominique Brown is the author of YourFinancesSimplified and InsiderRealEstateTips. He writes about “whatever he pleases” and today he wanted to write about credit and student loans.

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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  • John S @ Frugal Rules

    Great breakdown of how student loans can possibly impact your credit score. I’ve tried to pass along much of the same info to a family member who is still in college in order to encourage them not to take loans they do not need. They view it as “free” money when in all reality it’s not.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Thanks, John! It does seem like many college students do not fully realize the commitment they are making by taking out student loans. If I recall correctly, when I was applying to colleges, I imagined that salaries of $40k or $50k would easily pay off any substantial student loan debt (without realizing that the salary has to pay for living expenses first!). Hopefully more and more students are starting to understand this, however.

  • http://www.growingfamilybenefits.com/ Kevin Haney

    Credit scores are only one component lenders will consider. Debt to income is another important factor that is not part of most risk score equations.

    Mortgage lenders will always compare your monthly income to your monthly debt payments. If your monthly student loan payment is a high percentage of income, it does not leave room for much further borrowing.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That’s a good point, and especially relevant for recent graduates who have a high student loan amount and hope to buy a house soon.

  • credit score

    credit score probably reasonable to assume that a fair number of consumers
    receive no formal or informal education on the finer points of personal
    finance.

    Thanks!!!

  • HeatherAnn

    As a
    recent college grad myself, I now completely understand all the misconceptions
    I had when i first starting pulling these loans out. Its a pain in the butt to
    have to repay! my student loans account for almost 10% of my monthly gross
    income. thats a lot. same for my credit cards. I’m glad to know that my student
    loans have less of a negative impact than my credit cards do and am working diligently
    to pay my Visas off first. I was naive in thinking i could save money for a
    year or two and have enough for my first home. Now its looking more like 5-7
    years before i could be a first time home buyer.