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How Student Loans Impact Your Credit Score and Ways to Build Credit as a Student

Student loans can be a double-edged sword when it comes to your credit score. On one hand, they can help you build a solid credit history if managed responsibly. On the other hand, they can damage your credit if not handled properly. In this article, we’ll explore how student loans can affect your credit profile and provide other ways to build credit as a college student.

How Student Loans Can Help Build Credit

Student loans are a type of installment loan with regular monthly payments over a set repayment term. When you accept a federal student loan or get approved for a private student loan, the loan servicer or lender will report the new account to the credit bureaus.

If you’ve never dealt with credit before, student loans can help you establish a credit history for the first time. According to FICO, it takes at least six months after opening your first credit account to obtain a FICO® Score.

Even if you already have a student credit card or you’re an authorized user on a parent’s card, adding an installment loan to your credit file can diversify your credit mix, which also helps your credit.

Does Paying Student Loans Build Credit?

Payment history is the most influential factor in your FICO® Score, which means that making on-time student loan payments can help you establish a positive payment history over time.

Keep in mind, though, that college students typically don’t need to start making federal student loan payments until after they graduate, leave school, or fall below half-time enrollment. As a result, student loans may not have a huge impact on your credit score while you’re in school—though you can make small payments during that deferment period to be more effective.

When you pay off a student loan, your score might drop slightly, particularly if your student loan was your only installment account or if your remaining installment accounts have high balances relative to their original loan amounts. That said, this dip is usually temporary. The positive payment history on the account will remain on your credit reports for 10 years after payoff.

How Student Loans Can Hurt Your Credit

According to Experian data, student loan borrowers have an average balance of $38,787. That can be a significant financial burden, and if you don’t manage your student debt responsibly, it could potentially hurt your credit. Here’s how:

Delinquency

If you have federal student loans, your loan servicer will typically report missed payments after 90 days—the timeframe is just 30 days for private student loans. Just a single missed payment can damage your credit score significantly. The longer you leave your loans unpaid, the more damage your missed payments will do.

Default

Defaulting on federal student loans means that you’ve failed to make a payment for nine months—private lenders may start the process sooner. At this point, your student loan servicer or lender will send the debt to a collection agency, which can result in a collection account on your credit reports. The collection account, combined with your missed payments, can wreak lasting havoc on your credit score.

Debt-to-Income Ratio

Your debt-to-income ratio (DTI)—the portion of your gross monthly income that goes toward debt payments—isn’t part of your credit score. However, it is an important factor lenders consider when you apply for credit. The average student loan payment is $203, according to Experian data. But if yours is significantly higher or your income is relatively low, a high DTI could make it difficult for you to qualify for affordable financing on purchases such as a new car or a house.

Factors That Affect Credit Scores

Many factors play a role in determining your credit scores, and student loans can affect these in different ways. The primary scoring factors are often grouped into five categories:

• Payment history: A long history of on-time payments can help your credit scores, while a late payment can hurt your scores. The impact of late payments decreases over time.
• Amounts owed: The amount you owe on loans and credit cards, including your current student loan balance relative to the original balance, can affect your scores. As you pay down your student loans, the lower balance can help your scores. Additionally, your credit utilization rate on credit cards, or the percentage of available credit you’re using, can impact your credit.
• Length of credit history: A longer credit history, and a longer average age of accounts, could help your scores. Your student loan’s account history can start when your loan is disbursed, even if you don’t start making payments until after you graduate.
• Credit mix: Having experience managing multiple types of debt can help your scores. Student loans are a type of installment loan, which has a fixed repayment period. Credit cards and lines of credit are part of the other type of credit, revolving accounts, which have an indefinite repayment period.
• New credit: If you apply for a private student loan, the resulting hard inquiry (when a lender asks to see your credit report) may have a slight negative impact on your score. FICO will also consider how long it’s been since you opened your most recent account.

How to Improve Your Credit With Student Loans

As you work to establish your credit history, here’s how you can use your student loan debt to your advantage:

• Consider making small payments while in school: Your loan servicer or lender will typically allow you to make payments during your in-school deferment. In fact, making interest-only payments could help you save money in the long run—unpaid interest will be capitalized and added to your loan balance once you enter repayment after graduation.
• Set up automatic payments: Once you’re in repayment, set up autopay on your loans to ensure that you never miss a payment. Student loan servicers and lenders will typically give you an interest rate discount when you set up automatic payments, increasing your savings.
• Consider an income-driven repayment plan: If you have federal student loans and your payments are too high, consider getting on an income-driven repayment plan. These plans set your payments as a small percentage of your discretionary income, making it easier to keep up.
• Look into other relief options: If you’re experiencing financial hardship due to a job loss, death in the family, medical bills, or any other reason, you may qualify for deferment or forbearance on your loans. These programs can pause your payments for several months without hurting your credit.
• Catch up on late payments quickly: If you miss a payment by just a day or two, you may be on the hook for a late fee. However, you don’t have to worry about it damaging your credit until it’s 90 days late for federal loans or 30 days for private loans. That can give you enough time to bring your account current and avoid credit problems.

Other Ways to Build Credit as a Student

Whether or not you’re using student loans to help pay for school, there are several ways you can build credit from scratch. Here are just a few popular options to consider:

• Become an authorized user: When someone (often a parent) adds you as an authorized user to one of their credit cards, the card account’s history may be reported to the credit bureaus under your name as well. If the person has a history of on-time payments, this additional history could help bolster your credit—though the opposite is also true.
• Open a student credit card: Some credit card issuers offer student credit cards, which tend to have easier qualification requirements than traditional cards. Using the card for a small purchase and then paying the bill in full each month can be an effective way to build a positive credit history while avoiding interest.
• Consider a secured credit card: If you can’t qualify for a student credit card, a secured credit card could be a solid alternative. These cards don’t require you to be a college student, but you will need to provide a refundable security deposit—usually $200 or more—to get approved. You’ll typically get the deposit back when you close the account, though some card issuers may refund it and convert your account to an unsecured card with responsible use.
• Get a cosigner: If you need to borrow money for another reason, such as buying a car, consider asking a parent or other loved one with good credit to cosign your loan application. This arrangement can improve your approval odds and even help you secure a lower interest rate, making your monthly payments more affordable. Also, note that some smaller credit card issuers may allow cosigners on credit card applications.
• Use Experian Boost®: Experian Boost is a free feature that allows you to add nontraditional payments, including rent, utilities, cellphone, insurance, and even some streaming subscriptions, to your Experian credit file. Your positive payment history for these bills can help increase your FICO® Score powered by Experian data.

Be Proactive About Building Credit

While you may not yet have all the responsibilities and stressors of adulthood, your college years are an excellent time to develop good financial habits that can make it easier to establish a solid financial foundation for the future.

In addition to creating a budget, building your credit history is crucial to helping you hit the ground running after you graduate and begin your career. Experian Go™ is a free feature that can help you establish a credit history by providing you with insights into how your actions impact your credit and resources to help you learn more about understanding and improving your credit over time.

For any mortgage service needs, contact O1ne Mortgage at 213-732-3074. Our team of experts is here to help you navigate the complexities of mortgages and find the best solutions for your financial future.

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