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Student Loans and Your Credit Score: Everything You Need to Know

Student loans have a huge influence on credit scores. Savvy borrowers can take advantage of these rules and increase their credit scores.

Written By: Michael P. Lux, Esq.

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For many borrowers, student loans represent the largest debt on their credit report.

Thus, it shouldn’t come as a surprise that student debt impacts the complicated credit score formula in many different ways.

In this article, I’ll untangle the many different ways student loans may move your credit score up or down. I’ll also share some strategies to help you leverage student loan opportunities into a better credit score.

The Basics: How Student Loans Impact Credit Scores

Before generating a strategy to help your credit score, it is important to first understand the basics.

Three Ways Student Loans Help Your Credit Score

On-Time Payments – Payment history is a huge component of credit scores. If you are making timely monthly payments, you are helping your cause.

Diversified Credit Mix – Lenders want to see that consumers have managed different types of accounts over the years. Student debt adds to the diversity of your credit profile.

Length of Credit History – A limited or non-existent credit history is a significant issue. The longer you have been in the system, the better your score. For many borrowers, their first student loan is the oldest item on their credit report.

Three Ways Student Loans Hurt Your Credit Score

Late Payments – Missing a payment is obviously bad for your credit score. A single late payment can mean a drop of 180 points. Keeping up with student loan bills is often a challenge. As a result, large student loan bills are a massive threat to credit scores.

New Loans Hurt – New student loans can hurt your credit score in two ways. First, the inquiry required to get the new student loan may cause a temporary drop in your score. Second, the new loan lowers the average age of your credit history.

Default – If missing a payment is bad, defaulting is devastating. A default can last on your credit report for up to seven years, and lenders will be reluctant to loan you money in the future.

The Big Credit Impact that Doesn’t Change Your Credit Score

If you are worried about your credit score, it is probably because you want to qualify for new lines of credit, such as a mortgage or car loan, in the future.

It is crucial to remember that credit score isn’t the only number that lenders consider. Your debt-to-income ratio, or DTI, is just as important as your credit score.

When lenders make a credit decision, they look at the monthly debts of a consumer and compare them to the monthly income of the consumer. If you have monthly bills that eat up most of your paycheck, it will be hard to qualify for new lines of credit.

For this reason, student loan borrowers need to closely watch how their monthly payments get reported to the credit bureaus.

Sherpa Tip: Changing repayment plans can help your Debt-to-Income ratio.

If you are on the standard ten-year repayment plan for your federal loans, switching to a repayment plan with a lower monthly payment might make sense.

You can continue making larger payments to eliminate your debt as planned, but a lower monthly bill gets reported to the credit bureaus and improves your DTI.

Don’t Lose Sight of the Big Picture

If we focus too much on credit scores, it is easy to lose sight of more important goals. Just because something is good for your credit score doesn’t mean it is a good idea. Likewise, a decision might hurt your credit score, but it might also be the best choice.

There are two objectives that borrowers should always keep in mind:

  • Borrowers Must Eventually Eliminate Their Student Loans – Sometimes people get caught up in the credit age component of their score, so they think it is a good idea to let their student loan linger. This is a mistake. Paying interest to temporarily inflate your credit score is usually a bad idea.
  • The Goal of a High Credit Score is to Save Money on Interest – Nobody wants a high credit score for bragging rights. We want a high credit score so that we can qualify for future loans and get a favorable interest rate. Credit scores should be used to save money. Don’t spend money to improve your credit score.

What Student Loan Should I Pay Off First to Help My Credit Score

There isn’t one simple rule for determining the best loan to eliminate for credit score purposes.

Instead, borrowers should consider their current student loans and their future financial goals.

The following loans are all reasonable targets for credit improvements and other financial goals:

  • The Largest Monthly Payment – Knocking out the student loan with the largest monthly payment will have the biggest impact on your debt-to-income ratio. If your goal is to buy a house, erasing the largest monthly payment may do the most good.
  • The Smallest Loan Balance – If loan elimination is a major challenge and a distant goal, attacking the smallest loan will lead to the fastest result.
  • The Newest Loan – Credit age is a factor in credit scores. If you pay off the newest loan first, it preserves older debts and improves your average credit age.
  • Private Loans Before Federal – Private student loans are notoriously more difficult to repay than federal loans. Private lenders don’t offer income-driven repayment plans or student loan forgiveness. Because late payments and defaults are major risks to credit scores, eliminating the difficult student loans first can protect your credit score.

Sherpa Tip: Student loan refinancing is often a valuable shortcut for debt elimination.

Refinancing your loans may move your credit score up or down, but by locking in a low interest rate on a long-term loan, you can significantly improve your debt-to-income ratio.

The lenders offering the lowest rates on 20-year loans are listed here.

Student Loans and Credit Scores: Frequently Asked Questions

Over the years, I’ve received a ton of reader questions about credit scores.

The following questions are the ones I receive most often:

Do student loans hurt your credit score?

No. Student debt may increase or reduce your credit score, but credit agencies do not view student loans as unfavorable.

Can you get a 700 FICO credit score with student loans?

Absolutely. Student loans are not necessarily bad, and if you don’t miss payments, they can help your credit score considerably.

Does refinancing help or hurt my credit score?

Student loan refinancing usually helps credit scores but may hurt borrowers with limited credit histories.

In most cases, borrowers should decide whether or not to refinance based on the interest rates offered. If refinancing saves money, it is usually a good idea. One possible exception is borrowers who are about to apply for a mortgage.

What credit score do I need to get a student loan or to refinance student loans?

Generally speaking, if you are in the 500’s you will definitely need a cosigner, and it still might be a challenge. As you climb through the 600’s things, go from difficult to easy. (Lenders like LendKey and Splash are usually a good starting point for borrowers with credit score concerns.)

If your credit score is in the 700s, it is much easier to get approved and qualify for a low interest rate. Borrowers in this range that get denied normally have debt-to-income ratios to blame.

Do income-driven repayment plans like IBR, PAYE, and REPAYE hurt my credit score?

The credit score impact of switching repayment plans is minimal. However, a lower monthly payment may provide a considerable improvement to your debt-to-income ratio.

The one exception is for borrowers who qualify for $0 per month payments on an IDR plan. A $0 monthly payment may cause issues on future credit applications, as explained in this article.

Should I take out a student loan to build my credit score?

No. Getting a student loan to establish a credit history is a bad idea. There are much better options for helping your credit score.

Will paying off a student loan hurt my credit score?

It is possible. The good news is that if there is a negative impact on your credit score from paying off a loan, it is usually minimal and doesn’t last for long.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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