How Student Loans Impact Your Credit Score

Like many Americans, you may have burdensome student loans. In fact, with total U.S. student loan debt at $1.3 trillion, it has been described as a crisis that could have a major impact on the economic stability of current and future generations.

But there’s one area of life student loans affect that you might not realize: your credit score. Serving as your financial scorecard, a good credit score is essential for everything from getting a credit card to securing a place to live.

So how can student loans affect your credit score? The answers may surprise you.

How Credit Scores Are Calculated

Before we get into how student loans can affect your credit, let’s first review how your score is calculated in the first place.

You may not know it, but you actually have many credit scores – dozens, in fact, and each type has its own algorithm (or calculation) for coming up with that magic number. So you could, for instance, have an Experian credit score that differs from your Transunion score.

The credit scoring model that’s used most often by lenders and creditors is FICO. Here’s how a FICO credit score is calculated:

  • Payment history (35%): How often your payments are made on time.
  • Amounts owed (30%): How much debt you have in relation to the total amount of credit available.
  • Length of credit history (15%): How long you’ve been using credit.
  • New credit (10%): How often you open new accounts.
  • Credit mix (10%): How many types of credit accounts you have, such as student loans, credit cards, a mortgage, etc.

So now that you have an idea of how your credit score is determined, read on to learn some of the ways student loan debt can both help and hurt that number.

The Good: How Student Loans Can Help Your Credit

Positive payment history: As you can see above, the most important factor in determining your credit score is whether or not you pay your bills on time and in full. If you never miss your student loan payments and always get them in by the due date, you are doing a lot to help boost your credit score.

Additionally, as time goes on, having that account associated with your credit profile since your college days will help build a nice, long credit history.

Credit mix: Having a few different types of credit – such as credit cards, and auto loan, and yes, student loans – is good for your credit. Those pesky student loans could actually help you by diversifying your credit mix for a positive bump to your score.

The Bad: How Student Loans Can Hurt Your Credit

Delinquency/default: The number one way to quickly ruin your credit is to miss student loan payments. Because payment history is so important to your overall credit score, being delinquent on even one payment could cause a serious hit.

If your payments become 270 days or more past due, you are officially in default. Student loan default is incredibly damaging to your credit score, resulting in a drop of 100 points or more. Even if you rehabilitate your defaulted loans, that negative entry could remain on your credit profile for years to come. So if you’re struggling with your student loan payments, talk to your loan servicer right away to come up with a new plan.

Debt-to-income ratio: Your debt-to-income ratio does not directly affect your credit score, but it does affect your ability to obtain new credit, which is why it’s worth mentioning here.

If you’re planning to apply for a major loan (like a mortgage) in the near future, those student loans could get in the way. Lenders will look at your total monthly debt obligations – including student loans, credit cards, and even child support payments – and then compare that number to how much you earn. Known as your debt-to-income ratio, this number can make or break your loan approval.

Keep an eye on how much total debt you have, whether it’s a student loan or a big credit card balance, and consider paying off some of it before pursuing another major financial goal like homeownership.

How Student Loans Don’t Affect Your Credit

Credit utilization: How much money you owe in comparison to the total amount of credit available to you is a top factor in the calculation of your FICO credit score. This is measured by dividing your total debt by total credit, with the resulting percentage representing your credit utilization ratio.

A credit card that you maxed out, for instance, is bad news for your score because the utilization would be at 100%. Experts suggest keeping your ratio under 30%.

So does that mean the giant student loan balance that you’ve barely paid down is going to ruin your credit? Fortunately, not at all. Credit utilization is typically only impacted by revolving credit accounts (e.g., credit cards) and doesn’t normally consider long-term installment loans like student loans. As long as you make those payments, your credit should be unaffected, regardless of the balance.

Deferment/forbearance: If you experience financial hardship, you might need to apply for deferment or forbearance. These are two federal loan options that allow you to temporarily pause your student loan payments while you get back on your feet.

Although student loan deferment and forbearance are both noted on credit reports, neither of these will actually impact your credit in any way. As long as you begin making payments again once the deferment/forbearance period is over, your credit score will remain intact.

Student loans are complicated enough, and credit scores can add a whole new level of confusion. But as long as you understand the most important ways your student loans affect your credit score and make sure you’re doing what it takes to keep it healthy (such as making those payments on time), you’ll be on the path to minimizing your debt — and improving your credit, too.

This post was contributed by Andrew Josuweit, the CEO and President of Student Loan Hero, a company that combines easy-to-use tools with financial education to help the millions of Americans living with student loan debt manage their student loans smarter. Student Loan Hero has helped over 20,000 borrowers manage and eliminate over $1 billion in student loan debt since 2012.

Is there an area of personal finance that you’d like us to cover in a course or Fast Financial Fact? Where do you struggle with managing your finances? We’d like to know! Or are you an organization that’s interested in collaborating? Please get in touch at education(at)lendup(dot)com.

Disclaimer: LendUp is not providing financial, legal or tax advice. If you need or want such advice, please consult a qualified advisor.

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