One of the few unexpected perks of having student loans is that, if you are making on-time payments, they can help your credit score.
For many borrowers, a student loan is their first and oldest line of credit. Having a longer credit history can positively impact your credit score.
What if I don’t need a student loan?
If you don’t need a student loan because you have college funding through grants, scholarships, or help from your parents, it’s best to avoid taking one out.
Taking out a student loan just to boost your credit score would be an incredibly risky financial move. Taking on debt and paying interest merely to potentially improve your credit score slightly doesn’t make sense. Moreover, there are far better ways to build up your credit score while you are in college.
Why is an unnecessary student loan risky?
Student loans are a uniquely risky and expensive form of debt.
Student loan debt is more risky to borrowers than almost any other form of debt because of the rules surrounding bankruptcy. For example, if you have credit card debt or a mortgage and run into hard financial times, bankruptcy provides a way out. It is often a difficult path, but regardless of financial circumstances, you can get a fresh start. Student loans, on the other hand, receive special treatment in the bankruptcy world. Although it is not impossible to discharge student loans in a bankruptcy proceeding, it is incredibly difficult to do so.
Additionally, student loan debt is expensive. Interest begins accruing from the moment you borrow it. Even though you won’t receive a bill until you are out of school, your balance will continue to increase. With each passing month that the student loan is on your credit report “helping” your credit score, you are accumulating interest.
The real benefit of student loans to your credit score doesn’t come until you enter repayment. At that time, you can begin to develop a history of on-time payments. The problem is that you have to contend with the interest each month.
When you start repayment, the bulk of your payments go towards interest rather than reducing your principal balance. Thus, although making regular payments is good for your credit score, it is very expensive. Moreover, once the loan is fully paid off, it is no longer your oldest open line of credit, diminishing some of the credit benefits it once provided.
The better way to build up your credit score…
If you’re attending college without student loans and are exploring ways to build your credit score, you are miles ahead of the game. You have a huge advantage over your peers in terms of financial resources and financial literacy.
In this situation, probably the best step you can take to build your credit is to obtain a credit card. You should look for a credit card that doesn’t charge an annual premium, and perhaps shop around for one with a good “points” program that provides additional benefits like free items or cash back.
The key with the credit card is that you pay off your balance in full every month, without exception. By doing so, you will avoid paying any interest on your credit card and provide a valuable boost to your credit score.
This first credit card will become your oldest line of credit. The longer you keep that credit account open, the more positively it will impact your credit score. Unlike a student loan, which no longer contributes to your credit history once paid off, paying off your credit card balance does not remove it from your credit history because the line of credit remains open.
Credit utilization, which measures how much of your available credit you are using, also influences your credit score calculation. If you can borrow X dollars on your credit card, but use less than 20% of what is available, your score can improve. Over time, as you manage your card responsibly, your credit card issuer might increase your credit limit. This again can improve your credit score by lowering your utilization ratio.
It’s important to remember that these benefits are specific to credit cards. Using a debit card linked to a bank account doesn’t help build your credit, as these transactions are not reported to credit bureaus.
Bottom Line: Avoid Student Debt if Possible
While student loans can boost your credit score, they can be an expensive method for doing so due to the interest that accumulates over time. In contrast, a credit card can enhance your credit score without any cost to you, provided you pay off your balance in full each month to avoid interest charges. Additionally, a credit card can be more effective in improving your credit score than a student loan, as it helps build a credit history through regular, manageable payments and demonstrates your ability to handle revolving credit responsibly.
