How student loans affect your credit score

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A 2019 Bankrate study found that nearly three in four millennials reported delaying at least one major life or financial milestone as a result of student debt. It’s true — college graduates tend to see lower unemployment rates, so borrowing money to finance an education is a sacrifice that could lead to higher earnings later in life.

But managing student loans is a different story, and how you handle what you borrow can impact your credit score for better or worse.

Student debt and your credit score

According to the Board of Governors of the Federal Reserve System, outstanding student loans in the U.S. amount to a little over $1.6 trillion. On a more granular level, the average monthly payment on a student loan ranges from $200 to $300. Budgeting for this expense might seem daunting, but according to experts, simply making monthly payments on time is one of the key factors to maintaining — or initiating — good credit history.

“Student loans may be the first item, sometimes the only account entries in that credit report,” said Rod Griffin, director of public education at Experian. “And so you’d have what we like to think of as a thin credit file…making those payments on time is the first step.”

Monthly payments

A student loan operates like any other type of installment loan that comes with interest and a monthly payment. Lenders want to know whether you’re going to be able to repay them on time, so payment history alone makes up 35 percent of your FICO score. Because of this, Griffin says just one missed monthly payment can negatively impact your score, depending on the length of your credit file. “If you have just student loans and a short credit history, you probably don’t have scores that are very high — probably in the low-600 range if you’re just starting out,” Griffin said. “So missing payments, you would see your scores drop substantially whether or not you have really strong scores — if you have more information, it may drop less.”

Paying on time and in full will not only help establish the groundwork for a strong credit history, it’ll also help you stay on track to repay debt faster, especially if you pay over the minimum amount every month.

“There are a lot of ways to minimize the impact of a student loan, and one of the mistakes I see people making is that they don’t pay them down sooner, and they wait until they’re actually due,” said Leslie Tayne, founder and head attorney of Tayne Law Group. 

Student debt and credit variety

Credit mix accounts for 10 percent of your FICO score, meaning having a variety of useful credit accounts can be a boon for your overall credit score. Lenders like to see a variety of accounts managed well, so you shouldn’t add debt or lines of credit you don’t need or can’t handle financially.

An inability to pay can lead to a lowered score

Missing payments could have damaging consequences to your credit. If you’re 90 or more days late on a federal student loan payment, your loan servicer will report the missed payment to all three major credit reporting bureaus. 

Late payments on private loans typically show up on your credit report 30 days after the day you missed the payment. If these missed payments continue to pile up, you could find yourself defaulting on your loan

“If you default on the loan, this will stay on your credit score for seven years and is not something you should graduate from college carrying around,” said Jared Weitz, CEO and co-founder of United Capital Source Inc., in an email to Bankrate. You’re considered to be in default on a federal loan if you go 270 days without paying, and as little as 90 days of nonpayment on a private loan.

Debt-to-income ratio

Your debt-to-income ratio, or DTI, compares debt owed to your gross income. It’s not one of the scoring criteria like your credit utilization ratio, but those with high credit utilization ratios might also have high DTI ratios. The higher the DTI ratio, the more likely lenders are to see you as a risk. Student loans fall under the back-end category of your DTI ratio, which covers your monthly debt obligations. 

For example, if you pay $2,000 total in mortgage payments, credit card bills, student loans, etc., and your monthly gross income is $6,000, your DTI would be 33 percent (debt divided by income). An ideal back-end DTI ratio (including all expenses) is 36 percent or lower.

Technically speaking, adding more debt to your plate (like student loans), could increase your DTI ratio, which could then also impact how much or your ability to borrow money from lenders.

Build your credit and manage student debt at the same time

The Pew Research Center found college graduates with outstanding student loans are more likely to say they’re struggling financially than those who graduated without debt. 

About a third of respondents also said the costs of their degree outweigh the lifetime benefits. While student loans can provide an outlet for education that might not have been possible otherwise, it’s best to fully evaluate where you — and your family — stand financially before applying to minimize the cost of the student loan.

“Before you take out any type of loan, make sure you’ve evaluated other funding options such as your personal college savings, your parent’s college savings, financial aid, aid through school work-related programs such as work-study, fellowships and scholarships,” Tayne said.

Take what you need

Griffin says it’s important for students to understand exactly how much they need to cover expenses in order to avoid ending up with unnecessary debt. This means it’s OK to tell a lender you don’t need as much as what it says you qualify for. “The key with student loans is to only take the amount you need to cover your expenses. So often students don’t know that, and you take on more debt than you needed to, which can set you back financially when you then graduate from school and have larger loans than you needed.”

Weigh the pros and cons of federal and private student loans

There are two types of student loans — federal and private — and both can impact your credit, although federal loans don’t require a credit check for approval. For students with a thin credit files, we suggest starting with a federal loan. The interest rate on a federal student loan is fixed, whereas private student loans can come with variable interest rates that can change over time. 

Private student loan applications also require a hard pull on your credit, which can temporarily ding your score. Payment is needed right away on private student loans, whereas federal student loans typically offer a grace period for repayment that lasts until after you graduate. “Funding to pay the [private] loan is necessary right away to mitigate the risk of paying late and affecting credit score,” said Mariel Arraiza, SVP managing director at Eloan, in a statement. “Federal loans are available for students even when there is no credit history, thus approval chances are higher.”

Federal student loans also offer more ways to redirect the plan for your loan if you’re struggling to make payments, including income driven repayment plans (which tailor payments relative to what you make), as well as options for deferment or forbearance.  Some federal loans can be forgiven, but experts say it’s best not to rely on this method. 

“One of the things I don’t recommend is thinking that the federal government is going to forgive a large amount of debt, and that you’re going to fall into that category,” Tayne said. “It’s like waiting and hoping you’re going to win the lottery.”

Read Bankrate’s guides on federal, private, and repaying student loans.

Final thoughts

The key to making sure your student debt doesn’t become more of a hassle than necessary is to plan ahead. Evaluate where you stand financially, and see if you qualify for any financial aid first to minimize the overall cost of the loan. This could help prevent headaches, missed payments, and lowered credit scores down the road.