How to manage student debt to maintain quality credit
Student loans are part of life for many people. In some ways, they are not much different than other loans. Like an auto loan or a mortgage, student loans are generally installment loans which you pay back through monthly payments over a specified period of time, and your ability to make those payments has an impact on your credit.
But that’s just part of the story. There are other ways that student loans can affect your credit, both positive and negative. Let’s take a deeper look.
The positive impact of your student loan
Responsibly managing a student loan can help you maintain a quality credit score. Here are a few examples:
- Making your payments on time. This creates a positive payment history. Payment history has the biggest impact on your credit, accounting for 35% of your FICO score.
- Creating a good credit mix. A student loan is an installment loan, which is different from a revolving credit account (like a credit card). Having a good mix of credit accounts makes up 10% of your FICO score.
- Building a long credit history. You’ll likely pay your student loans over a long period of time. While that may feel a bit overwhelming, the silver lining is that you're building a credit history at the same time. And that makes up 15% of your FICO score.
The potential credit challenges of student debt
Debt-to-income and debt-to-credit ratios
Your student loan can affect both your debt-to-income ratio and debt-to-credit ratio.
Your debt-to-income ratio is the percentage of your monthly income that goes to repaying your debt. You can figure this ratio by adding up all your debt and dividing it by your monthly income (before taxes and other deductions from your paycheck). If you have a large amount of student loan debt, it can drive up that percentage. Although your debt-to-income ratio doesn’t directly affect your credit score, it is a factor that lenders may look at if you apply for a car loan, home loan, and more.
Your debt-to-credit ratio is the amount of credit you have available to you compared to the amount you’re actually using (your credit utilization). The Consumer Financial Protection Bureau recommends keeping your credit utilization below 30%. As you might guess, your student loan could raise your ratio and that could affect your credit score.
Federal parent PLUS loans and co-signers
The federal parent PLUS loan is a program that enables parents to take out loans to help cover college costs for their children. This type of student loan only affects the parent. In other words, any missed payment can ding your parent’s credit score, but it won’t show up on your credit report.
With a co-signed loan, your parent is using the power of his or her credit score to help you qualify for the loan. A co-signed loan appears on both your credit report and your parent’s report. And any missed payment will affect both scores as well.
Refinancing your student loan
You may decide to explore refinancing your student debt if it seems like you could get a more favorable rate.
Note that with any application, the lender will make a hard credit inquiry. Hard inquiries can have a negative impact on your credit score - generally five to 10 points. It may take a few months for your credit score to recover, and the hard credit check stays on your report for up to two years.
If you’re going to shop around for a refinance, it’s a good practice to make all your applications in a fairly short period of time. Applications made within a 14-day period usually only count as a single hard inquiry. In addition, some lenders may offer a pre-qualification, allowing you to get a rate estimate that won’t affect your credit – a benefit to shopping around.
What to do if you’re struggling
If you find yourself at risk of missing payments and worried about your credit score, here are some things you should know.
- If you have a federal student loan, loan servicers will report late payments 90 days after a missed payment. If you have a private student loan, lenders will report late payments after just 30 days.
- You may be able to change the terms of your loan. With a federal student loan, you may be able to get a repayment plan that better fits the income you’re earning. Some private lenders will offer modified payment plans, so check with your provider to see what programs are available.
- In some cases, you may be able to temporarily pause your payments by requesting deferment or forbearance. It’s important to note that, even though you may receive a deferment, interest keeps accruing during that time, adding to how much you’ll owe in the end.
