Do Student Loans Affect Your Credit Score?
Taking on a student loan to pay for your education is a big commitment but, provided your debt is sustainable, it’s also a valuable investment in your future that will pay for itself over time.
Student loans will also have a significant effect on your credit score both immediately and as you pay them—but there is also a lot you can do to make that influence as positive as possible.
Let’s look at the likely impact of student loans on your credit history and score, how that will affect your ability to borrow money in the future, how paying off your loans will change your credit score, and some smart ways to protect your creditworthiness as you go about paying off your loans.
HOW DO STUDENT LOANS AFFECT CREDIT SCORES?
Taking a loan to pay for your college education will most likely lower your credit score significantly, especially if you’re like most students with only a relatively short credit history to date.
Over time, however, paying off a student loan can have a positive impact on your score, allowing you to demonstrate your ability to manage and repay debt over an extended period. According to the credit bureau TransUnion, there are three reasons for this:
PAYMENT HISTORY
Paying your bills on time makes up a full 35% of your credit score. Therefore, simply making your payments on time will maintain and even improve your score. That said, if you miss even one payment, this can have an immediate and lasting negative impact on your score.
CREDIT UTILIZATION
This tracks how much of your available credit that you actually use. While it’s considered important for short-term revolving debt, it’s not as significant for student debt, which is usually a long-term installment loan.
That means even high student loan balances won’t affect your score nearly as much as would a hefty credit card balance.
LENGTH OF CREDIT
A longer credit history helps your score. While taking on loans as a student might be tough, it can also give you a head start in establishing a good track record of responsible debt management.
DO ALL STUDENT LOANS AFFECT CREDIT SCORES?
Importantly, not all student loans will affect your credit score, at least initially. It depends on the lender. If you borrow directly from the federal government, most loan applications will not require a credit inquiry, which can temporarily lower your score.
That said, Department of Education Direct PLUS loans are an exception. These loans are extended to graduate students, or parents of students, and do require a “hard” credit check.
Loans from private lenders, however, will always involve a hard credit inquiry that will dip your credit score for at least a few months.
Over time, both federal and private loans will affect your credit score either positively or negatively based on your payment history and the length of your credit. That means missing payments on a federal loan is just as serious as defaulting on private lending.
DO STUDENT LOANS AFFECT CREDIT WHILE YOU ARE ATTENDING SCHOOL?
If you have a federal loan, you’re generally not required to make payments while you are a student, which means the government is allowing you to defer payments on the loan until after you graduate. Private loans, however, usually require you to start paying off the loan while you’re still in school.
According to the credit bureau Equifax, student loans will appear on your credit record whether deferred or not. If you have a deferred loan, your credit score won’t be negatively affected while you are still a student, but once the deferment period ends, you must start repaying the loan on time.
Remember, whether you have a government or private loan, if you miss any deadlines for payments due, your credit score will be negatively impacted.
DO STUDENT LOANS AFFECT BUYING A HOUSE?
Unless you are fortunate enough to pay off your student loans very quickly in the early stages of your career, there’s a good chance you will still owe money when it becomes time to consider buying a home.
Outstanding student debt will affect your ability to qualify for a mortgage because lenders look not only at the total amount of debt you still owe, but also your debt-to-income (DTI) ratio, or how much of your monthly paycheck goes to paying outstanding loan balances.
Having more debt will limit the mortgage amount you are likely to be approved for and may mean you qualify only for loans with higher interest rates. A DTI above about 36% will also limit your ability to qualify for lower-interest loans or even to apply for a mortgage at all.
The best thing you can do to prepare for buying a home is to pay off as much of your outstanding student loans as you can. If you are carrying private student loans, consider consolidating or refinancing them to lower your monthly payments.
If you have federal student loans, however, think twice about refinancing them because you could miss out on tax advantages or possible deferment or forgiveness of the loans by the federal government.
WILL MY SCORE DROP WHEN I PAY OFF MY LOAN?
After putting in all the hard work to pay off their student loans, many graduates are often surprised to see their credit score take a dip when they make that final payment. There are a few possible reasons for this:
Credit mix: Your credit score benefits from a mix of different debt types, from credit cards to long-term loans, because this demonstrates your ability to manage different types of debt simultaneously. Paying down a student loan would remove this type of loan from your mix and leave you with fewer types of debt on your credit profile.
Length of Credit: Closing a long-standing loan like a student loan can also affect the average age of the debt in your credit accounts, reducing the length of your credit history.
Fortunately, credit score dips after you’ve paid off your loan are usually relatively short-lived. The effect of reducing your overall debt and continuing to make on-time payments on your outstanding balances will soon offset these factors.
DO STUDENT LOANS DROP OFF AFTER 7 YEARS?
This is a surprisingly popular and very misleading idea that should be set straight. Student loans are not reduced or forgiven after seven years and in almost all cases must be completely paid off.
This myth may arise from the “seven-year rule” which limits how long negative items can remain on your credit report. Regardless, the “seven-year rule” has nothing to do with loan repayment.
In truth, your student loan will need to be repaid and will continue to affect your credit score until you do. Federal loans may only be forgiven in the case of some disabilities or possibly reduced over time for those at qualifying jobs at certain federal, state, or local entities or nonprofits.
GHS FCU: SMART ADVICE ON STUDENT LOAN DEBT
At GHS Federal Credit Union we know how hard it can be to manage your credit and repay student loans on time while still getting ahead in your career and personal life.
That’s why we’ve made financial counseling a core part of the overall financial wellness we strive to provide for each of our members. No matter your personal or financial situation, we offer free, private financial counseling tailored to your exact situation, which includes:
Budgeting and Payment Strategies
Understanding Your Credit Report
Optimizing Your Debt-to-Income Ratio
Home Buying Advice, and more
Click below to learn more about our financial counseling services and connect with one of our counselors today.