We’ve become a nation of student loan debtors. We’ve all heard the saying that the only things certain in life are death and taxes. These days, one additional certainty is the student loan: increasingly, higher education is necessary for jobs in every industry.
But do you know how your student loans affect your credit score?
When I was a bright young thing fresh out of school, I didn’t have a clue. Going to a private school, all I knew was that I had to pay back this staggering amount of money. When I was 18 and signing the papers, the amount of money involved seemed imaginary. At that age, my largest purchases involved lunches with friends and clothes, but certainly nothing like tens of thousands of dollars a year. Once I graduated and started working, the amount of money I owed became all too real when my student loans steadily chipped away at my salary.
As I learned, student loans can both help and hurt your credit score. Beyond the financial necessity of making payments, we’ll explore how you can ensure your student loans won’t damage your credit score. In fact, with a proper understanding of how student loans affect your credit score, they can actually help you raise it.
How Credit Score Agencies Regard Student Loans
Student loans are considered “good debt” by credit score agencies and lenders because they represent an investment in your future. Even now, with the lingering aftereffects of the Great Recession, higher education still translates into higher income. Student loans are also usually low-interest installment loans, and lenders take that into account as well. Because of these factors, you can make student loans work for you so they can positively affect your credit score.
Putting your student loan into deferment or forbearance also won’t affect your credit score. It will be mentioned in your credit report, but your score will remain intact.
Make it a habit to check your credit score regularly as you make payments on your student loans. It can be extremely satisfying to see your number rise over time, providing motivation to keep on paying off those loans.
Building Your Credit History
Your credit score reflects five different factors: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), types of credit utilized (10%). One way your credit history improves over time is through steadily making payments on time. However, many new graduates don’t have a long credit history. When they enter the working world, their short credit histories can hurt them when they apply for credit cards, rental apartments, car loans, and even for utilities.
This is where student loans can actually help you build a solid credit history. As long as you make regular payments on time, your credit score will also improve as those payments will affect your payment history, the amounts owed, and the length of your credit history.
Don’t Be Late On a Payment
Of course, to take advantage of this, you’ll need to avoid being late on a payment. The flip side of the coin is that being late will have a major effect on your score, especially as your payment history is 35% of your credit score. Once you are late with payments, or if your student loan ends up at a collection agency, your credit score will take a major hit that will be very difficult to overcome. This is also true if you have put your loan into deferment or forbearance and are late with a payment.
And since you can’t discharge this debt even through bankruptcy, you’ll want to do whatever it takes to avoid being late on a payment.
Paying Off Your Loan Early Can Affect Your Credit Score
One unusual factor that many people don’t know is that paying off your student loan early can have a different impact on your credit score than paying in the allotted time. In certain ways, paying off an installment loan early could be less helpful to your credit score than paying it off month by month, because it could reduce the “diversity” of credit accounts you have open. The diversity of accounts is one small factor in how credit scores are calculated. However, in most cases it’s still worth paying off the loan early if you can, because being debt free is obviously good for your finances (and your credit score) in the long run.
The psychological relief of paying off a student loan is probably well worth it, and in the long run paying off loans in full is a good thing for your credit score.
Image credit: ffennema