How Student Loans Affect Your Credit Score

studentloansandcreditscore

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.

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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

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  • Mike

    Wow, that’s pretty awful that paying off loans early negatively affects your credit score. It’s not “counter-intuitive” though, just rigged I guess.

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

      Thanks for the comment, Mike. Yes, it’s definitely too bad.

      • Mike

        Yeah I’ve been thinking about this again recently, glad you commented today.
        I wonder if you can renegotiate the timeframe?
        Like say I win the lottery. Can I then talk to the loan servicers and say, “I’d like reevaluate the 10-year plan.”

        What strikes me, having just went through the federal loan counseling weeks ago, is that it’s not exactly emphasized that the time-period is set in stone.

        If I say “I pick the 10-year plan” how can that be changed later?

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

          That’s an interesting question. I’d like to assume that you could renegotiate the timeframe, but I’m not sure I’ve ever heard of anyone doing this. We know the timeframe can be negotiated upwards – as in the case of the Income Based Repayment plan, with a 25-year timeframe. Deferments and forbearances could also change the timeframe, at least a little bit. Anyway, glad we could help and best of luck!

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

      Hi Mike, I just wanted to reply again because we were notified in the comment above by Ivan that our last section overstated the danger to your credit score of paying loans early. The reality is paying off a student loan early could be less beneficial than paying it off in the agreed upon time period, but the difference is small. And if you have the ability to pay off a loan it’s probably a good idea to do that.

  • Ivan

    This article is fairly inaccurate and seems to be based on common myths about credit and financial planning. First, paying off your loans will save you money on interest so even if it did lower your score a bit it would still be a good idea because you will have more money as a result. Second, old accounts that you paid off stay on the report and continue to affect the average age of accounts (at least they do on mine). Also, credit scores estimate your likelihood of default – paying your loans off decreases your likelihood of default, so it can increase your score and is unlikely to significantly decrease it. Lastly: “lenders will miss out on a regular source of income: the interest accrued through payments” – this has nothing to do with credit scores, as they do not measure how profitable you are to the banks – they measure your likelihood of default nothing more nothing less. TL;DR – pay off your loans as quickly as possible and you’ll be better off.

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

      Ivan, you are correct. Thanks so much for pointing this out. I’ve updated the article to include more accurate information regarding the effect of paying off student loans early on your credit score. Please let me know if you have any other feedback on this post (or any other post).