How Do Student Loans Affect My Credit Score?

Michael Lux Blog, Student Loans 1 Comment

Student loans can have a tremendous impact on your credit score.  If you plan smart and stay on top of things, they can actually be a huge asset to your credit score.  However, a few student loan mistakes can cause your credit score to plummet.  Today we will discuss the ways that student debt can change your credit score and offer some tips and suggestions to make sure student loans don’t stand in the way of your goals.

Payment History

One of the biggest factors in the credit score formula is the payment history.  Make payments on time and your score goes up.  Miss payments or make late payments and your score drops.  Student loans, like any other debt, are included in this calculation.

From a FICO score perspective, the biggest direct impact that your student loans will have on your score is the payment history.

Oldest Credit Line

For many student loan holders, their student debt is among the oldest debt on their credit report.  Like fine wine, age of an item on your credit report is a good thing.  The longer you have had your student loan and stayed current, the better.

The downside to this factor is that paying off a student loan can actually cause a slight dip in your credit score.  Obviously getting rid of the debt is much better than keeping it, but don’t be surprised if you pay off your oldest student loan and see a slight dip in your credit score.  The good news is that this is a relatively minor factor and shouldn’t give borrowers any hesitation to eliminate their debt.

Lines of Credit

If you don’t have any lines of credit, you won’t have much of a credit score.  However, if you have too many, it can hurt your score.  Generally speaking, a few lines of credit with a high balance or credit limit is better than a ton with low balances and low limits.  Like the age factor, it is included in your credit score, but it isn’t a huge component.

The impact here is most often seen by student loan borrowers who consolidate their loans.  For example, when a recent grad takes advantage of their new degree and income to lock in lower interest rates, they may see 8 student loans become one large consolidated loan.  In addition to lower monthly payments, this financial move can improve your credit score.

Looking Beyond FICO…

The biggest impact to your credit from student loans isn’t necessarily to your credit score.  Instead, the real impact of student debt is to your creditworthiness.  As an example, student debt can be the reason you are denied a mortgage loan… and it isn’t because of your credit score.

The two biggest factors that banks and lenders look at before loaning someone money is their credit score and their debt-to-income ratio.  As we have seen, student loans do affect the credit score.  However, the effect on debt-to-income ratio is often the killer part.

Creditors considering lending money want to see that a perspective borrower is low risk.  A good credit score shows a good history of debt management.  The debt-to-income ratio shows an ability to make payments.  Creditors want to see that you have way more money coming in each month than you have going out.  They look at your credit report to determine this information.  You report your income, but the credit agencies report your monthly debt.  If you have huge monthly payments on your student loans, it makes getting future credit approvals very difficult.

Bottom Line

Student loans can impact your credit score in a number of different ways.  However, if you are trying to get approval on a credit application, the weight of student debt is especially apparent on your debt-to-income ratio.  This ratio is the reason that student loans can often turn an approval into a rejection on a credit application.