One of the few unexpected perks of having student loans is that if you are making your payments on time, they can help your credit score.
For many borrowers, a student loan is their oldest line of credit. The older the line of credit, the better the credit score.
What if I don’t need a student loan?
If grants, scholarships, or your parents are paying for college, and you do not need a student loan… don’t get a student loan.
Taking out a student loan just to help your credit score would be an incredibly risky financial move. Borrowing money and paying interest for the possibility of a slightly higher credit score doesn’t make sense. Most importantly, 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 dangerous, and they are expensive.
Student loan debt is more dangerous than any other form of debt because of the bankruptcy rules. If you have credit card debt or mortgage debt and run into hard financial times, bankruptcy provides a path to a clean slate. It is often a difficult path, but regardless of financial circumstances, you can get a fresh start. Student loans get special treatment in the bankruptcy world. They are not impossible to discharge in a bankruptcy proceeding, but nearly impossible.
Additionally, student loan debt is expensive. When you borrow the money, interest starts accumulating from the first day. Even though you won’t have a bill until you are done with school, your balance is still growing. With each passing month that the student loan is on your credit report “helping” your credit score, you are paying interest.
The real benefit to your credit score doesn’t come until you enter repayment. At that time, you can begin to show a history of on-time payments. The problem is that you still have interest each month. When you start repayment, the vast majority of the payment goes to interest, with a small portion reducing your principal balance. While this repayment is good for your credit score, it is very expensive. Once you pay the loan off, it is no longer your oldest open line of credit, erasing the value of much of the work that you did.
The better way to build up your credit score…
If you are in college without using student loans, and you are looking at ways of building up your credit score, you are miles ahead of the game. From a financial resource and financial literacy, you have a huge advantage over your peers.
In this situation, the best thing that you can do for your credit score would be to get a credit card. You should look for a credit card with no annual premium, and perhaps shop around for one with a good “points” program so that you can get some free stuff.
The key with the credit card is that you pay your balance off in full every month, without exception. As long as you pay off your balance in full each month, you will never pay any interest on your credit card. Going this route can be incredibly valuable to your credit score.
This first credit card will become the oldest line of credit. The longer you have that credit account open, the more it will help your credit score. Unlike a student loan, paying off your credit card balance does not erase it from your credit report, because the line of credit is still open.
Additionally, credit utilization is part of the credit score calculation. If you can borrow X dollars on your credit card, but use less than 20% of what is available, your score improves. As you continue your relationship with your credit card company, they will likely raise your credit limit. This again improves your credit score. However, it should be noted that these perks apply to credit cards only. A debit card associated with a bank account will not have the same credit benefits.
Bottom Line: Avoid Student Debt if Possible
While student loans can help your credit score, it is a very expensive way to improve your credit score. However, a credit card can improve your credit score at no cost to you, and it will do more to help your credit score than a student loan.