Education can be expensive. A lot of students and parents resort to taking student loans to get through college. Paying off the student loan can take a considerably long time. You might wonder if it affects your credit score and hence your ability to borrow further.
When you take a student loan, it is reported to three credit reporting agencies. This includes TransUnion, Experian, and Equifax. The fact that it is reported means that student loans can affect your credit score.
Even if you don’t plan on borrowing anytime soon, a strong credit score should still be important to you. This is because credit scores aren’t just used for taking loans. Instead, they also play a role in deciding whether you qualify for credit cards or not. Not to mention that some house owners consider it when renting their spaces. The higher the credit score, the lower the insurance premium and interest rate you can qualify for.
Does this mean student loans necessarily affect your credit score negatively? To understand their role in your credit, it is essential to identify both the positive and negative effects of taking a student loan.
Remember, it all boils down to how you are repaying your loan rather than the fact that you took it in the first place. For instance, if someone pays off their loans promptly, this would help in building a positive credit history. Therefore, in such a case, your credit score will go up. However, if you miss your repayments, your credit score will be negatively affected.
Positive impacts of student loans
Let’s see how student loans can help your credit score.
It influences 35% of your credit score, so paying on time can increase your score drastically
Did you know that your loan repayment history constitutes for 35% of your credit score? This is why repaying them on time can lead to a good credit score. However, this isn’t the case with all your repayments. Payments like car insurance and rent are only ever reported in your credit report if you stop the payments or miss them.
So, while timely payments might not be reported to the bureau in most cases, loan payments are reflected. Hence, this can allow you to showcase to a potential lender how responsible you are with your payments. It builds your credit. Those who don’t haven’t taken auto loans or have credit cards will find student loans to be a great way to build credit since early on.
The longer the repayment period, the longer the credit history
The length of your credit history accounts for 15% of the credit score. Now, student loans are almost always long-term plans. Most of them are accompanied by 10-year repayment packages. Therefore, they help you in building a long credit history.
Remember, don’t merely put off paying off your loan early because of this. If you can pay it off soon, you should do it. 15% of credit score isn’t worth being in debt for longer than you have to.
Ease in building credit mix
Having a diverse credit mix ensures that taking loans doesn’t impact your credit score a lot. 10% of the credit score is dependent on this.
The more different credit you have, the better your credit score will be. So, if you already have credit cards or have taken an auto loan, getting a student loan will further build your credit mix.
Negative impacts of student loans
If you fail to repay in the frequency decided, the fact that you have a student loan can negatively impact your credit score as well.
Here are a few of the dire consequences you will have to face if you don’t manage your student loan repayments properly.
Lower score due to the opening of credit accounts
Opening a new credit account, regardless of why you do so, will decrease your score. This is because with every new account you open, the mean age of accounts reflected on your credit report will decrease.
Remember, you need a high average score for a strong score.
The possibility of hard inquiries
If you apply for a student loan from private borrowers, the application process may include the lender requesting your credit report to gauge your credit history. This comes under hard inquiry.
Every hard inquiry negatively impacts your score a bit.
Increasing debt load
The mere fact that you have a student loan that you are paying increasing your debt load. If you are paying back in installments, it might not be as harmful as outstanding debt. But, it still lowers your score.
Even if you take credit score out of the equation, having a student loan might increase your debt to income ration which might reflect your inability to afford to pay off any more loans. So, qualifying for other loans will get hard.
Late payments will decrease your score
We mentioned how timely payments could positively impact your credit score. Well, as logic goes, if you don’t pay on time, this too will be reflected on your report and hence will hurt your credit score.
Bad payment history will be reflected in your report for seven years. Many services give a leeway of a maximum of 30 days before reporting your delinquency. Try never to surpass this limit.
The effect of defaulting
Considering how late repayments will affect your score, you can imagine what destruction defaulting on your loan will cause. Defaults also stay on your report for seven years. They don’t just reduce your score. They signify a cautionary tale for lenders.
When they see it, they will symbolize you as a risky investment. Hence, your chances of getting loans will become very slim.
What if you aren’t able to afford repayments?
Are you finding it hard to pay off your student loan? If so, the first thing you need to do is talk to your loan servicer. The good thing about federal student loans is that you can change your repayment plans in times of need. You can also stop your payments for a while by choosing to defer them.
If you have taken private student loans, things might be a tad more complicated for you. However, you can still approach your lender and ask for forbearance or deferment of a loan. What hardship policies they have will differ from lender to lender.
If you defer your loan, your credit score won’t get affected. However, you must pay the decided payments on time.
Make sure to keep up with your payments. If you do so, you will be able to avoid all adverse effects of student loans. Instead, the loan will end up helping your credit score. Whether it be via diversifying your credit mix, signifying a positive payment history or increasing your payment history length, if you allow it, student loans can be more beneficial than you think.
Just keep in mind the following key takeaways:
- The effect student loans have on your credit score is the same as the effect other loans have.
- Just because you have a lot of debt on you because of your student loan doesn’t mean your credit score will decline.
- Payback on time and you are good to go.