How Do Student Loans Affect Your Credit Score?

Student loan debt is fairly common these days. As of 2018, more than 44 million Americans were dealing with student loans – so don’t feel alone. And while paying off your loans may be an added stress during these already complicated years of young adulthood, it’s good for you to know that having a student loan may actually help your credit score and even allow you to build a credit history that could enable you to get a mortgage and take out a car loan in the future.

Keep in mind that not all credit is created equal. For instance, student loans are considered installment loans similar to mortgages and auto loans because they’re repaid over time with a fixed number of payments, resulting in eventual full repayment. In comparison, credit card debt is considered revolving debt because the balance goes up and down, it’s open-ended, and is dependent on when you make a purchase and how much you spend.

Having $50,000 in student loan debt is not the same as having $50,000 in credit card debt. According to FICO®, 7% of consumers with more than $50,000 in student loan debt had credit scores of more than 800 points. (FICO scores range from 300 to 850.) Not too shabby.

But much of your credit score can depend on how you manage your student loans: Do you make your payments on time? Do you pay extra each month? Have you missed any payments? Here’s a look at how those issues, and student loans in general, can factor into your credit.

Do I Need a Good Credit Score to Take Out a Student Loan?

The answer depends on whether you’re talking about federal or private student loans. Federal loans don’t take credit scores into account, which is why most every borrower gets the same interest rate regardless of financial profile. However, federal PLUS loans do require that borrowers not have an adverse credit history, which is defined by FinAid as “being more than 90 days late on any debt, or having any Title IV debt within the past five years subjected to default determination, bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment or write-off.”

For private lenders, your credit score is usually a key factor in determining not only student loan approval, but also the attached interest rate. In other words, the better your score, the better your rate.

Which Credit Scores do Private Lenders Use?

Most private student loan lenders use FICO credit scores to determine whether to extend credit and at what interest rate. Since FICO is used widely throughout the lending industry, including by mortgage, auto loan, and credit card providers, it gives lenders an apples-to-apples comparison of potential borrowers.

How is My Credit Score Calculated?

Unfortunately, how FICO calculates your credit score is kind of a black box. While the various factors and weightings used in the calculation are publicly available on FICO’s website, its algorithm is proprietary, which means that no one can predict exactly how a specific financial event will affect your score. For example, a late payment will likely reduce your score, but by how many points is anyone’s guess.

That said there are generally three key ways to improve your credit score: pay bills on time, keep credit card balances low, and reduce the amount of debt you owe.

How Does a Late Student Loan Payment Affect My Credit Score?

Making payments on time is obviously important, but what you might not realize is exactly how damaging it is to not pay on time. Even if your credit history is pristine, it only takes one 30-days past due report to cause a material change in your score. Whether you were short on cash or just simply forgot, the FICO algorithm doesn’t distinguish—and the result is the same.

So, if you have trouble remembering to make your payments, set up an automatic payment plan; most lenders will give you a small discount on your interest rate for doing so. When you know you can’t make a payment on time, talk to your lender or loan servicer right away.

Most federal loan lenders and some private lenders offer loan deferment and/or forbearance, allowing you to temporarily suspend payments, which will minimize the impact on your credit score. But remember, there’s absolutely nothing your lender can do to help if you don’t return their calls.

One of the purposes of a credit score is to alert lenders of how likely you are to repay your debts. Something that will likely have a positive effect on your credit score is making your student loan payments on time and in full each month. Your credit payment history accounts for 35% of your FICO score and just one late payment could negatively impact your credit score.

Once a late payment is reported to the credit bureau, it could remain on your credit report for up to seven years. Making your payments on time and in could positively impact your credit score, meaning you may qualify for better credit terms when it comes time to take out a car loan or mortgage.

Will Rate Shopping Different Student Loan Lenders Hurt My Credit?

We hear this question a lot from grad school borrowers and those refinancing student loans to get the best interest rate possible on a private loan. One factor that can be a red flag for FICO is the number of inquiries it receives from lenders wanting to see your credit report. In other words, if it looks like you apply for more credit often; it could negatively impact your score. But the good news is that FICO attempts to distinguish between a request for a single loan and a request for many new credit lines. As long as you rate-shop in a concentrated period of time, you should be okay.

If you really want to avoid inquiry overload, do your homework before applying for a loan. Private lenders typically list online the range of rates they offer, as well as general eligibility criteria. Researching that info will give you a good idea of whether you’ll qualify before you formally apply.

Also, be sure to ask lenders if they can tell you the interest rate you would receive without doing a “hard” credit pull, which might affect your score. You can’t get a loan without an eventual inquiry, but this service allows you to compare interest rates worry-free before applying for a loan.

Will Refinancing Student Loans Help My Credit?

Refinancing student loans at a lower interest rate can have an indirect positive impact on your credit. For example, refinancing may lower your monthly payments, making it less likely you’ll miss or be late with a payment. And if you refinance federal loans with a private lender (in effect, turn your federal loans into a private loan), rest assured that credit bureaus don’t view these two types of loans any differently.

Are There Issues With Paying Off Student Loans Too Quickly?

Some people reason that because education debt is “good debt,” FICO must view it more favorably than other types of debt. And because credit scores can be improved by having open accounts that are paid on time, they think that paying off a student loan early might actually work against their score. But, while there’s no definitive answer to this question (remember: black box), there are a few things to keep in mind before buying into this belief.

First, FICO doesn’t see your student loan debt as being good or bad. In fact, the agency doesn’t distinguish it from any other type of installment debt, such as mortgage or auto loan debt. Incidentally, while installment debt is different from revolving debt (like credit card debt), it’s generally better to have positive track records with both types of loans.

Second, it’s true that FICO likes to see how you manage your debt. So, if you have an open account in good standing, that could help your score—but the impact would likely be small. And closing any account satisfactorily is generally a positive thing for your credit, so that could help your score, too.

Bottom line: Instead of worrying about how prematurely paying off your student loan will impact your credit score, consider the potential trade-offs. For example, how much extra interest are you paying by leaving the account open? Also, a high loan balance may make it harder to qualify for new loans—something to think about when it comes time to buy a home.

Main Point – Don’t Default on Your Loan

The worst thing you can do is ignore your monthly loan payment. If you are even one day late with your payment, you’ll be considered delinquent and you’ll be charged a penalty for missing that payment. Once a missed payment is more than 90 days delinquent, your loan servicer will report it to the three major national credit bureaus.

This could lower your credit score and negatively affect your ability to get a new credit card or qualify for a car loan or mortgage. After 270 days of a missed student loan payment, your status changes to default and your student loans are due in full with any accrued interest, fines, and penalties.

Consider Refinancing Your Loans

There are several options for repaying your student loan and keeping negative information from impacting your credit score. One possible way you could lower your monthly payment is to refinance your student loans. Additionally, if you now have a better financial profile than when you took out your original loans, you may be able to lower your interest rate and save money over the life of the loan.

Credit is a powerful tool that can allow you to do a lot of great things, but if you’re not careful, it can hold you back. For many people, student loans represent their first experience carrying a large debt load, which means mistakes are almost inevitable.

The most important thing you can do is learn how to take good care of your credit score—and eventually, it will take care of you, too.