How Student Loan Debt Can Harm Your Credit

Though student loans can be a good thing for your credit, it’s also easy to get into trouble. If you aren’t careful with payments or take on too much debt, your credit score can suffer as a result.

Missed payments. Remember how important payment history is for your credit score? The last thing you want to do is miss a payment. Because payments comprise 35 percent of credit history, missing and late payments have a negative impact.

The severity of a missed payment will depend on how late it is and how often you tend to miss payments. The later it is, the more detrimental its impact. Even so, just one payment that’s 30 days late could cause a drop of 90 to 110 points for someone with a score of 780 who has never missed a payment in the past. Further, missing payments will also negatively affect the credit of any co-signers on your loans.

Although deferment and forbearance do not have a negative effect on your payment history, any payments missed before implementing the plan are negative. If you’re struggling to make payments, talk to your student loan servicer before you miss one.

Default. If you really let your student loan payments slip, you could end up in default. That is a much worse situation for your credit.

For most federal student loans, your loan is considered to be in default if you are at least 270 days behind on payment. At that point, your entire loan balance becomes due in full for federal student loans. Private student loans typically fall into default status when you’re at least 120 days late on your payment. When you’re in default, you’ll likely face collection activity and may be sued to collect the debt.

A default stays on your credit report for up to seven years from the date of first delinquency. Research from the Brookings Institution estimates about 40 percent of student loan borrowers will default by 2023. There is good news for federal student loan borrowers, however. There is an option for removing the default from your credit history.

If the borrower defaults on the federal student loan, they have a one-time opportunity to rehabilitate the debt. This will remove the default from their credit history. In order to rehabilitate a defaulted student loan, you must work out a revised payment with your loan servicer and make nine payments within a period of 10 months.

However, allowing your loan to reach default status can harm your credit even if you do loan rehabilitation. Even with the default status removed from your credit history, loan rehabilitation does not remove the record of late payments leading up to the default.

Debt-to-income ratio. Another factor that affects your credit is the amount of debt you owe, which accounts for 30 percent of your score. Revolving credit, such as a credit card, is used to determine your overall credit utilization and its impact on your credit. However, too much installment debt, such as student loan debt, could adversely affect your ability to borrow, too.

That’s because it could increase your debt-to-income ratio, also known as DTI, which is a measure of your financial health and is often evaluated by lenders when determining if you can afford payments on a new loan. Your DTI is the amount of your monthly gross income that has to go toward debt repayment. The more you have to repay each month, the higher your DTI. Although your DTI does not affect your credit score, it does influence lending decisions.

However, federal student loans allow borrowers to enroll in income-driven repayment plans if their payments are too high. This bases the monthly payment on the borrower’s income, as opposed to the amount they owe. This can significantly reduce the debt-to-income ratio, increasing the borrower’s eligibility for mortgages and other types of consumer credit.