A credit score is an important qualification for the financial position of an individual. It affects various spheres of our lives, including our ability to get lines of credit, buy a house, receive insurance, etc. Therefore, students want to learn how do student loans affect credit score. In later paragraphs, we will dive into that.
When it comes to student loans and credit scores, these two elements are interdependent. On the one hand, credit performance can be a significant determinant of whether an individual can get a student loan to finance education. On the other hand, existing student loans and the borrower’s repayment behavior impact credit performance.
If you wonder how student loans affect your credit score or vice versa, read this guide carefully. The impact of student loans can stay on credit history for a long time. Hence, it is necessary to understand the consequences on your credit performance from the beginning.
What is a Credit Score?
Lenders usually use the FICO credit scoring model. A credit score is a numerical determinant ranging from 300-850. It is the reflection of the borrower’s creditworthiness and trustworthiness.
The score depends on many factors, but mainly on the individual’s prior performance, such as the timely payments of debt, credit usage, credit history length, recent activities, etc. The higher the score, the more creditworthy the individual is.
Usually, a score above 700 is considered good, while between 800-850, it is excellent. People in the U.S in 2020 had an average score of 710.
Many entities check credit scores for different purposes. You can observe its impact on daily life when:
- you want to get a new loan
- an employer makes a decision regarding hiring or promoting
- insurance company use a credit score to determine insurance costs
What Credit Score is Needed for Student Loans?
Before student loans impact credit history, credit performance can impact your ability to get student loans. However, the impact depends on the student loan type. If you plan to get federal loans, most of them do not require a credit check.
As loans are designed for students, there is a high likelihood that students will not have the necessary credit score to get a loan. Hence, the government mostly ignores this factor when distributing student loans. Some federal loans such as Parent and Graduate PLUS loans can require a credit check.
Meanwhile, private student loans mostly require a good credit score. Private lenders aim to generate profits. Hence, it is necessary to ensure that the borrower will repay the debt on time and in full. In this process, a credit score helps them to identify creditworthy borrowers.
Usually, borrowers are required to have a 670 or higher FICO credit score. Alternatively, if the borrower has a low credit score, the lender can require a co-signer. A co-signer is a third party who guarantees the repayment if the borrower fails to repay the debt.
How Do Student Loans Affect Credit Score?
If you want to get federal loans, your credit performance might not matter in qualifying for these loans. However, the student loan will sure have an impact on your future credit history.
Short Answer: Depending on how you repay the student loans, they can either improve or deteriorate your credit score. The impact of student loans on credit performance is almost the same as other debt types on credit history.
When you start the repayment, make sure you make on-time payments in amounts shown in the bills. Federal loan borrowers usually start repayment six months after graduation. For private student loan borrowers, repayment can start as soon as the debtor receives the funds. If the borrower follows loan terms in repayment, the student loan can improve credit score through:
- having a history of accurate payments
- increasing the length of credit history
- creating a mix of credit
On the other hand, if your payments are not timely, you miss them, or you do not pay the repayments at all, the student loans will negatively impact your credit score.
How do Student Loans Affect Credit Score?
Now, let’s elaborate on the short answers and understand how do student loans affect credit scores in detail.
When calculating FICO scores, different factors impact the result. Payment history has the strongest influence on scoring, and it accounts for 35%. It is followed by remaining debt amount – 30%, length of credit history- 15%, credit mix-10%, and new credit-10%. You need to make payments on time and in the full amount you see in the bill. In this way, you can continue maintaining a good history of payments, increasing your credit score.
Longer Credit History
The length of credit history is also a determinant of FICO credit score. It accounts for 15% of your credit score determination. If you deal with successful repayment of debt for long periods, your credit performance boosts. Student loans usually have a long repayment period ranging from 10-25 years. When you consistently pay your loan over this period, your creditworthiness and credit score increase.
It is also why students lack a high credit score as they would not have a long credit history. Therefore, most federal student loans do not check credit performance.
Diverse Credit Mix
Another important factor for FICO is the credit mix which indicates the diverse types of loans and lines of credit the individual has. There exist two types of loans- installment and revolving. Installment debt requires consistent repayment over time. Student loans, car, or mortgage loans belong to this category.
Meanwhile, a revolving debt like credit card debt allows individuals to get various funds each month and payback with the income. If you have both types of debt in your credit history, your credit score will increase. Similarly, if a student loan is the only debt type belonging to the installment debt category, you can notice a slight decrease in the score when you finally pay off your debt.
Making Late Payments
As mentioned before, the history of payments comprises 35% of the FICO score calculation. Compared to other factors, consistent repayment is the most influential factor. Hence, missing a single payment deadline can affect credit scores significantly.
The decrease happens when the lender informs the major credit bureaus about the late payments. The timing of notice depends on student loan types. For federal loan borrowers, the lender waits up to 90 days to inform the credit agencies. Meanwhile, private student loan lenders can inform credit bureaus in 30 days, which means you have less time to fix the situation and avoid decreased credit scores.
Keep in mind that this delinquency status- late loan payment information is communicated to the credit agencies- can significantly impact your credit score lasting as long as seven years.
Defaulting on Student Loans
After late payment status, if you do not repay the debt for a long time, your student loan can go into default status. The default will happen 270 days after missing the payment for federal loan borrowers, while for private student loan borrowers, this period is shorter- 30 to 90 days.
When defaulted, the borrower will face major negative consequences on the credit report. The credit score decreases significantly, and the loan default event stays in credit reports for as long as ten years. During this time, borrowers will face challenges if they want to get a new loan, rent an apartment, or request insurance for their cars. Hence, you need to be careful to avoid default status on your loans.
What if I cannot Make Payments?
You already know how student loans impact your credit score. We discussed that the impact depends highly on the repayment ability. If you repay the debt on time, the impact will be positive, and your credit score will increase. In contrast, late, skipped, or non-payment will decrease the credit score, and you will face further challenges. Specifically, you need to avoid default status as its consequences last for years. You might be unable to request a new loan, get an apartment or even find a decent job.
If you face financial difficulties and you are unable to make accurate payments, you have to find alternative ways. As mentioned, payment history is the most influential factor for determining FICO credit score. Therefore, it is essential to maintain a good payment history.
If you are in financial trouble, you can talk to the loan servicer or lender to get a forbearance period. Loan forbearance is a temporary non-payment period lasting a few months. During this time, you can think of long-term solutions.
If you have federal student loans, you can request a loan servicer to move your loan to Income-driven repayment plans. Federal borrowers have access to several repayment plans. However, Income-driven repayment plans depend on the income level. It means, if you earn less, you will pay less for the debt repayment, and repayment will fit your budget.
Meanwhile, both federal and private loan borrowers can utilize student loan refinancing. Refinancing allows getting a new loan and using the funds to repay the existing loan. Usually, the new loan has lower interest rates. Hence, it can be a money-saving technique for borrowers.
For further guidance, you can have a FREE consultation with Student Loans Resolved debt specialists and learn more about how do student loans affect credit score.