How Student Loans Affect Your Credit Score
The relationship between your student loans and your credit scores has two stages. Applying for students loans, to begin with and then the manner and time how student loans are paid off.
Applying For Student Loans
First, there is getting a student loan or loans for school. While a credit score is not considered when applying for Federal student loans, a poor one (below 650) can stop an application for a private student loan dead in its tracks. Since Federal loans cannot be used for housing or transportation costs, the inability to get a private loan can still prevent some students from attending college. Applicants for Federal loans should also keep in mind that even with a good credit score, a bankruptcy that was applied for within 90 days of filing a FAFSA application will result in it being rejected.
If you are concerned about your credit scores, you can always check on them with the three major credit reporting agencies. Before you do that, ask for a copy of your credit report from each of them. According to Federal law, you are allowed a free copy from these agencies each year. If there is information that is false, misleading or happened over a decade ago, then you need to look into having it changed or deleted as soon as you can. One of our own contributors here at Student Debt Relief was once denied an auto loan because he was reported as deceased by one of the credit reporting agencies. It took over three months for him to be ‘resurrected’.
Repaying Student Loans
After graduation, repaying a loan quickly and without missed payments is the best way to build and keep a good credit score. However, even with this simple rule to follow, there are a number of things to be careful of; some of them are going to surprise you.
Paying off your student loan early may actually damage your credit score. Student loans are installment loans which, unlike credit card debt (revolving credit), it does not look better to creditors to have the lowest balance possible. Future creditors understand that a student loan means there is no larger balance of available credit and that your monthly payment will not change over the lifetime of the loan.
Since paying off an installment loan early can mean a loss of income (interest) on the loan to the lender, it may actually send the wrong signal to potential future creditors and lenders. This can mean future loans with a shorter term, but a higher interest rate so they will get a better return on their loan to you.
Delinquency And Deferment
Resolve any delinquency immediately. Although it can harm your credit score to pay off too quickly, the damage will be much worse to just leave a student loan delinquent in the hope that you will find a new job or another source of income in order to “catch up”. Once you resolve a delinquency by establishing an Income Based Repayment, Income Contingent Repayment or another repayment option, your credit rating will quickly begin climbing back to its pre-delinquent level.
Student loans taken out with a private lender have fewer repayment options than a federal student loan. Even so, most banks will work with you to help not just you and your credit score, but to keep “bad” loans off of their books. No bank manager or loan officer wants to have to answer about why a loan is delinquent and have to go through the process of attaching paychecks if they can find a solution agreeable to both parties. The key here is to notify your lender before you miss a payment and to set up a new repayment plan. If it is too late for that, then you will need to establish a new repayment plan quickly and follow up with the lender and the credit reporting agencies to make sure any bad information about it has been updated to show a repayment plan is now in place.
A student loan in deferment or forbearance will NOT hurt your credit score. Payments are not required when a loan is deferred, so you cannot be late in making them. If you need a short term of relief from a student loan to get your finances back on track, or to deal with an unexpected expense such as an extended hospital stay, then this is definitely an option for you.
Good Credit Loans
As mentioned above, student loans are installment loans. They are weighed less against your credit score than other types of loans and much less than credit card debt. This also makes them an excellent way to add history and diversity to the credit score of a new college graduate that might not otherwise have a credit history except for a credit card or two. This is also a loan that is supposed to improve earning potential and not to spend on a luxury item. All of this puts student loans, federal or private, in the category of “good credit”.
Federal Student Loan Advantages
Unlike private lenders, federal student loan lenders do not report past due accounts until they are 60 days past due and even then until the end of that month. This provides a federal student loan holder additional time to pursue repayment options or request deferment for the loan.
When deferment is granted, federal student loan lenders report it to the credit agencies automatically; in some cases, they will even backdate it if appropriate. As an example; if you return to school to pursue another degree, but did not file the appropriate notification paperwork, the period for which your loan was delinquent can be removed from your credit history once everything has been filed correctly.