Student loans are often your first major financial obligation, which can be stressful and overwhelming.
Understanding the relationship between student loans and credit is important, as student loan payments (or lack thereof) can have a big impact on your credit score.
Student loans can be both positive and negative for your credit history, so staying on top of your student loans is essential.
The Positive Side of Student Loans
Typically, we think of student loan debt as being bad.
Who wants thousands upon thousands of dollars hanging over their head?
However…if you manage your student loan debt responsibly, it can do wonders in helping you build good credit, so it’s not all bad.
Student loan payments can impact three of the five major components of your credit score:
1. Payment history
2. Length of history
3. Credit mix
Payment history is the most heavily weighted component of your credit score, accounting for 35 percent of your overall credit score.
Therefore, paying your student loan bill in full and on time every month can have a positive impact on your overall credit score.
Even if you just make small monthly payments or interest-only payments while your loans are in the grace period or in-school status, these payments are still considered real payments on your credit history, and can help to build your credit before you even truly begin making your normal (sadly, larger) payments.
Length of credit history is 15 percent of your overall credit score.
By taking out student loans, you will establish a credit history earlier than if you had waited until after college to begin borrowing funds.
While you shouldn’t take out student loans if it’s not necessary just for the sake of establishing a credit history, this is just an added perk if you do have to take out student loans to complete your education.
Credit mix also weighs in to your credit score; 10 percent of your total score, to be exact.
Lenders enjoy a diverse mix of debt as opposed to all one type (only a car loan, only credit card debt, etc.). Student loans add an additional type of debt to your credit history, which thus helps to strengthen your overall score.
The Negative Side of Student Loans
While student loans can help with your credit, they can also cause serious issues if you are not careful.
Missed payments and default both play a large role when assessing the impact of your student loans on your credit score.
As mentioned previously, payment history is the most important factor that can affect your credit score.
Therefore, missing student loan payments can be detrimental to establishing a solid credit history.
The severity of a missed payment will depend on several factors, such as how late the payment is eventually made and how many other payments you have missed.
Even just one missed payment can lower your score by 90 points. Further, a missed payment also adversely affects the credit score of any co-signer on your student loans.
If you are struggling to make payments, talk to your loan servicer about deferment and forbearance, as these have no impact on your credit score.
While missed payments are bad for your credit history, really losing track of your loan obligation and slipping into default is a much worse situation for your credit.
For federal student loans, default typically occurs when your student loans have not been paid for 270 or more days.
At that point, the entire balance of your student loans will become due in full for federal student loans.
Private student loans generally become default after 120 or more days of being late on your payment.
Once your loans are in default, you will likely face collection activity and may be sued by your lender for collection of the debt.
A default stays on your credit history for up to seven years, starting from the date of first delinquency.
While there are certainly a multitude of ways that student loans can have a detrimental effect on your credit score, by staying on top of managing your payments, you can see a positive impact on building a strong credit history.
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