Investing in a college education can be a worthwhile pursuit, leading to more job opportunities and increased compensation over your life cycle. But if you mismanage student loan debt, your credit could suffer. Poor credit is guaranteed to negatively impact your financial future.
Your credit is comprised of a credit report, and a credit score. Your credit report is your history of account and payment information. Creditors, insurers, employers, and other businesses use your credit report to evaluate your trustworthiness as a borrower. You can download your credit report free from annualcreditreport.com each year.
Your credit score is a three-digit number intended to reflect the quality of your credit report. Your FICO score, which ranges from 300–850, is calculated based on several different pieces of information in your credit report. If your report shows only positive remarks, your credit score will likely be very good. If you have problems on your credit report, such as missed payments, your score will be lower. You can check your credit score for free through many credit cards, or Credit Sesame.
How Student Loans Affect Your Credit
Your FICO credit score is based on five different categories:
Student loans show up on your credit report, and influence your credit score all five of these categories. Let’s talk about each, ordered from most important to least important:
Payment history: If payments are made on time, student loans will improve your credit score as part of a positive payment history. Student loans in deferment or forbearance are not considered late, and contribute to a positive payment history. Late student loan payments will lower your credit score, just like late payments on any other type of account. If you have late payments or missed payments, those negative remarks will stay on your credit report for seven years.
Amounts owed: Student loans are considered an installment loan. An installment loan generally has a starting balance that’s repaid over time with a fixed number of payments. Home mortgages and auto loans typically fall in this category, too. Credit cards are considered a revolving line of credit. The amount of available credit you’re using on revolving accounts is more heavily weighted than installment loans, and the total amount owed on student loan debt does not have a significant effect on your credit score.
Still, prospective lenders will consider student loan balances when evaluating whether or not you can manage additional debt. For example, if you’re looking to get a mortgage, prospective lenders want to know that you can afford to make your monthly payments. If you have a lot of student loan debt, the lender is going to factor your debt into their assessment of your ability to make additional debt payments. Many lenders want to see a reasonable debt-to-income ratio before making additional loans.
Length of credit history: Student loans can lengthen your credit history, which is a positive remark on your credit. The age of a student loan is measured by the number of months since the loan was first opened.
Types of credit used: Generally, your credit score will increase by utilizing a mix of credit types, such as student loans (installment credit) and credit cards (revolving credit).
New credit: Applying for new credit can cause a slight drop in credit score if the lender makes a hard credit inquiry. The good news is that many firms who offer student loan refinancing will not pull your credit until the last step of the process (when you finish applying), and you can shop around and check rates without a hard credit pull. Even when your credit is pulled, the effect is small and short-lived. Your score will continue trending upward if you make timely payments.
Summary and Conclusion
With student loan debt, payment history is likely to have the largest impact on your credit. Being an installment loan also helps diversify your credit profile, which should increase your credit score over time. The other factors contributing to your credit are less affected by student loan debt.
How has student loan debt impacted your credit history? Please share with a comment below.