How Student Loan Debt Affects Credit Scores

With college tuition skyrocketing, many have found it necessary to borrow money to obtain an education. The average student graduates with $29,400 in student loans and, worse yet, struggles to pay it back. Can student loans be as crippling to your credit score as your budget?

Loans in Forbearance or Deferment

Once you graduate or leave school, you have six to nine months before you begin making payments (depending on the type of loans you have). While you are in school, and during the six- to nine-month period following your time in the educational system, the loans are considered to be in deferment. If you have financial difficulties after you leave school, you may be able to get your loan into forbearance — a period of time in which principal and interest payments on your loan are temporarily delayed.

If your loans are in forbearance or deferment, do they have an impact on your credit score? The simple answer is no; however, the loans may make it difficult to qualify for a new loan. If you recently graduated from school and you are looking to get a car loan or buy a home before your first student loan payment is due, lending underwriting may still consider your student loan payments when calculating your debt load. (Most lenders don’t like to see more than 36% of your gross income going towards loan and credit card payments.)

In other words, if you can show that you will be in forbearance or deferment long enough, banks will not hold the student loan payments against you when calculating debt ratios. Otherwise, the loans will count against your total debt.

The Positive Effect of Student Loans on Your Credit

Having student loan debt can affect your score positively in several different ways. If you consistently make your student loan payments on time, this helps build up your payment history. Since your payment history constitutes 35% of your credit score, paying on time helps to raise it. Student loan debt also adds to the diversity of your debt records, which is something that FICO likes. Since the diversity of your debt is 10% of your total score, having student loan debt can have a positive impact on your score – so long as you’re always on time with your payments. The final way that student loan debt helps your FICO score is that it increases the length of time you’ve had a credit history, which accounts for 15 percent of your total FICO score.

Will Paying Off My Student Loan Early Hurt My Credit Score?

Paying off an account does not remove it from your credit history; your student loan will remain on your credit report for seven more years. Therefore, even if you pay off your student loan early, positive or negative payment history will likely stay on your credit report for seven years. Keep in mind, though, that lenders still have a responsibility to demonstrate that their credit reporting has been fair, accurate and fully substantiated. Any abrogation of those standards may require that associated negative credit reporting be removed before that maximum credit reporting period.

Reducing your overall level of debt could have a positive effect on your ability to get a new loan, but student loan debt is considered installment debt and is factored into your credit score differently from revolving debt such as credit cards. The amount of revolving debt you carry is 30% of your score; there is no corresponding risk factor for installment debt. Therefore, paying off installment debt will not have a big effect on your credit scores. Sadly, some consumer advocates regard this as another way the system is unfair: responsibly paying off student loans all at once (instead of spending the money more frivolously) won’t likely afford the kind of credit score gains that common sense might suggest.

The big positive to paying off student loans early is that you will save money on interest payments. If you make your student loan payments on time each month and can kick in a little extra towards paying off the principal, that reduces the amount of money you’re paying towards interest.