Student loans can have a major effect on your credit score, so it pays to understand the relationship between student loans and credit. On one hand, borrowing and paying back student loans can do wonders for your credit history. On the other, a misstep like a missed payment can send your score plummeting.
How Student Loans Can Positively Impact Your Credit
Think student loan debt is all bad? Not quite. If you manage your loans responsibly, they can help you build good credit. In fact, student loans can positively impact three of the five major factors that make up your credit score – payment history, length of history and credit mix.
Positive payment history. The most heavily weighted factor in your credit score is your payment history, which makes up 35 percent of your overall FICO credit score. That’s why one of the best things you can do for your credit is pay your student loan bill on time and in full every month.
Even if your loans are in deferment, such as during the in-school and grace periods, the fact that you’re not currently making payments is neutral and won’t count against you. During these periods, you are still meeting the loan requirements.
But some lenders allow borrowers to make small payments – such as a flat $25 per month or interest-only payments – during in-school deferment and the grace period following graduation. These payments get reported as real payments on the borrower’s credit history, having a positive impact if the borrower makes them on time.
That means it can help your credit score if you make student loan payments, even if you don’t have to yet. Getting started early on paying back your loans means building a positive payment history – and good credit – that much sooner. Not to mention, you’ll knock off some of the accrued interest from your balance.
Credit history. Your credit history is a record of how long you’ve been using credit, including how long various accounts have been open and active. Lenders like to see that you have plenty of experience using credit, so the longer your credit history, the better. It’s also a fairly important factor in your credit score, accounting for 15 percent of your FICO score.
College students may have a thin or nonexistent credit history since they’re young and may not have had a chance to take out many credit cards or loans. And even though not all student loans require a credit check, they all show up on the credit file of the borrower. For a student with limited credit history, this can have a dramatic impact on their credit.
By taking out student loans, you start your credit history earlier than if you waited until after graduation to borrow money. Though no one should go into debt just for the sake of their credit score, getting an early start on credit building is a nice perk of student loans.
Credit mix. In addition to a lengthy credit history, lenders like to see a diverse one. That’s why your credit mix, or types of credit used, makes up another 10 percent of your FICO credit score. Whether its auto loans, credit cards, mortgages or student loans, the more types of credit you have on your file, the better it is for your score. Plus, if you don’t have a long credit history, a good credit mix may be even more impactful.