Learn the effects of student loans on credit scores, including payment history, credit mix, and managing delinquencies.
For a lot of young adults, student loans represent more than just debt — they are a rite of passage. However, even more than the funding for an education, this debt carries a significant power over something that may matter even more: your credit score. So, let us take a look at the connection between student loans and credit scores, the upsides, and the down.
The Recording of Student Loans on Credit Report
Both federal student loans and private student loans appear on your credit report as an installment loan. It’s the same category for auto loans or mortgages. Here’s how it works:
When You Apply for a Loan
Since there is no credit check for federal student loans, your credit report does not take an immediate hit either. In contrast, private student loan applications will trigger a hard inquiry. Even if your application is rejected, it still slightly reduces your credit score when a lender checks your credit. This is only a temporary impact, but it’s something to be keenly aware of if you’re planning other financial endeavors.
When Payments Begin
After your loan has been disbursed, it displays just like an installment loan on a credit report. Each month, they report the payments you make—or fail to make. If you are up to date or dropping behind, lenders care.
Default and Its Consequences
A student loan default, which usually happens after more than 270 days of missed payments, can stay on your credit history as a mark of disgrace for years. According to Bruce McClary at the National Foundation for Credit Counseling, “Negative account information will typically remain on your credit file for seven years from the date it first became delinquent.”
Effect of Student Loans on Credit Score
The effect of your student loans on your credit score can go either direction, but it depends on how you manage your payments (and debt in general).
The Positive Side
Diversifying Your Credit
A mix of credit types (installment loans vs. revolving credit like credit cards) also helps with your credit score. 10% of your total score comes from this category. Taking out and properly managing a student loan shows you can manage different kinds of debts.
Establishing a Payment History
Payment history is 35% of your credit score—the biggest single contributor. Making your student loan payments on time can improve your score over the years because it indicates reliability to lenders.
The Risks
This is a better position to be in but it does not come without a catch:
Debt-to-Income Ratio (DTI):
Student loans can change your credit mix but a large loan balance can also lead to wrong DTI ratio calculation as per guideline. This may hinder your qualification for more credit, like a mortgage or auto loan.
Delinquent or Default on Payments:
With respect to payment providers, federal university loan lenders usually tend to take an extended time frame to document a delinquent cost to credit score scoring organizations—90 days or more, giving clients some slack. On the other hand, private lenders may report missed payments sooner, depending on their reporting policy. Just one missed payment can bring down your credit score several points.
Default and Collections:
You might imagine defaulting on the loan as nothing more than a bad mark on your credit report, but it has much more serious repercussions than that. Defaulting tends to result in collection attempts, wage garnishment, and a credit score decrease that could take years to recover from.
Managing Student Loans Wisely
Knowing the impact of student loans credit score is just the beginning. The difficulty comes in how to manage these loans. These are the actions you might take:
Set it and Forget it:
Many lenders will actually discount your interest rate if you sign up for automatic payments. This means you won’t forget to pay a bill.
Keep Lenders in the Loop:
If you need assistance with your payments, don’t ignore your servicer so that you are delinquent. Federal loans provide access to income-driven repayment plans, while private lenders may provide hardship programs.
If It Is Time To Refinance, Do It Wisely:
Refinancing can also help to lower your interest rate, but be careful. Refinancing a federal loan with a private lender means giving up access to federal repayment options and protections.
Final Thoughts
A double-edged sword—student loans can either propel your financial health or hold it back. As long as you are mindful of your loans and make as much of your repayments as possible, the risk should be minimized and student debt can also play to your advantage quicker than you might expect.
Your credit score or your CIBIL score is not just a number, but much more than that. Managing your student loans wisely is one of the building blocks of your financial health (for the things you are successfully saving for such as a home (hopefully), a trading portfolio or just making it in life). This means every payment counts, not just on your balance, but on what you are paving for the future.
