Student loans you take out for college will affect you as you look for credit and loans in the future. Your credit score is positively affected by the on-time student loan payments you make, and negatively affected when you miss or make late payments. Lenders will use your credit score to help assist them in determining whether or not to approve you for a loan.
What is a Credit Score?
FICO® score or VantageScore® are two leading companies for reporting your credit score. Both have scores ranging from 300 which is considered poor, to 850 which is considered excellent. Your score is a combination of different factors that work together to define your ability to assume new debt.
Your overall credit score is made up from your payment history, credit utilization (or the amount you owe on your revolving credit divided by your total available revolving credit), the age of your credit history, credit mix, and recent hard credit inquiries. When it comes to credit utilization, you generally want to keep this under 30%. Your credit score reports on your financial history, ranging from credit cards to student loans, car loans, mortgages & more and analyzes how well or poorly you paid back money lent to you.
More >>> What is a Good Credit Score
How do Student Loans Affect Your Credit?
If you have a credit card, adding in a student loan will help build your credit mix, a smaller contributing part of your overall credit score. Continually paying regular, on-time payments will help you build credit, as the largest part of your credit score comes from making payments on time.
Both federal and private student loans are classified as installment loans. An installment loan is a loan for a fixed amount of money (along with interest) for a set period of time. As a borrower you agree to make payments until the loan is paid off. Being a responsible borrower and paying your monthly payment in full over time shows lenders that you can successfully manage multiple loans and lines of credit. If you were to make late loan payments, it could reduce your credit score and stay on your credit report for seven years.
Your student loans can also impact your debt-to-income and your debt-to-credit ratios. Your debt-to-income is your monthly debt payments divided by your gross monthly income. The debt-to-credit ratio is the amount of credit used compared to the amount of credit you have available. Lenders are looking for lower ratios when evaluating your creditworthiness. While your debt-to-income ratio may not affect your credit score like your credit utilization will, a high debt-to-income ratio may prevent approval of additional debt.
Importance of Monthly Payments
Late or Skipped Payments
Late payments on student loans can negatively affect your credit score. Student loans can be considered delinquent the day after a missed payment. Private student lenders typically will report a missed payment as being delinquent after 30 days. Federal student loans are usually reported as delinquent after 90 days. Late payments will stay on your credit report for up to seven years impacting your access to additional credit.
If you do not submit payments for a certain amount of time (federal student loans are usually 270 days, Federal Perkins loans are one missed payment, and private student loans are typically 120 days), your loan will enter default. When your loan enters default, the entirety of your loan balance could become due immediately, you may lose the ability to use deferment or forbearance, and federal student loans may no longer be an option until you resolve the defaulted loan. Your tax refunds, federal benefit payments, and wages may be withheld and garnished to pay down your loan. Contact your loan servicer for more information to assist you if you feel you cannot make a payment or will need to pay it late. There are a lot of options to help you keep your federal student loans out of default, like options of forbearance, deferment, and repayment plans.
Minimum Monthly Payments
Ideally, your monthly payment plan is manageable and allows you to continually provide for yourself and your dependents. While making more than your minimum payment (and applying those funds to the principal) can help you pay off your student loans more quickly, there may come a time where making the minimum monthly payment becomes a struggle.
To prevent a late payment, or missing a payment entirely, you should look at your repayment plan to see what your options are and talk with your loan servicer to determine the best course of action. If you have a federal student loan, you can change your repayment plan at any time. There are a number of different repayment plans that can help you keep your loan current and prevent it from defaulting. You can also contact your lender to see if you qualify for a forbearance or deferment, to postpone your loan payments to allow you some time to catch up on your finances.
Consecutive On-Time Payments
Making regular payments on time can help you build a positive credit history. As you make payments on time and your student loan ages, the average age of your credit also increases. This can provide your credit with a positive boost.
Many loan servicers give you the option for autopay to help you continually make your minimum monthly payment on time. There may be a .25% to a .50% decrease in your interest rate if you enroll in auto pay, thus doing so may lower the overall cost of your loan!
As you work to develop a good credit history and credit score by making consecutive on time payments, it will help your financial future and possibly make lower interest rates available to you as you show your financial responsibility and creditworthiness to lenders.
Avoiding Student Loan Default
If you don’t think you’ll be able to make your payment, call your loan servicer to discuss possible options. Your lender may be able to lower or pause the monthly payments for your student loan. Loan servicers are often willing to work with borrowers to ensure payment is made, but communication is key.
If you are at-risk of defaulting on your federal student loan, you may notice an increase in contacts from your loan servicer. Do not ignore them! They may be able to help you avoid default. If you loan happens to go into default, depending on the type of federal student loan, the government guaranty or backing of those funds, will kick into effect. If you have a FFEL loan, your lender will submit a claim with their guaranty agency and your loan may be transferred for further collection. They will try to collect on your account and return it to good standing, however, if they are unable, eventually your loan will be transferred to the U.S. Department of Education’s default management group. If you have a Direct Loan, your loan will move to a default student loan servicer, like Maximus, for further collection and default management of your loan. All the months you were in delinquency and the default will be reported to the credit bureaus.
If you have a private student loan, it is not insured by the federal government. If you default on a private student loan, your lender will transfer your account to a collection agency. The delinquencies and default will be reported the credit bureaus.
Before defaulting on your student loan, talk to your lender as soon as possible, and ideally before your payment becomes past due. Loan companies may have more options to hep you before you default, because once you default you tend to become ineligible for a lot of those flexible repayment options for even your federal student loans.
Options to Prevent Default:
•Income-Driven Repayment Plans for Federal Loan Borrowers
If you have a federal student loan, an income-driven repayment plan is designed to make the debt from your student loan more manageable by setting your payment based on your income, household size, and state of residence. This is a unique repayment plan option because other types of debt only base your payment on your repayment term, outstanding debt, and your interest rate. Chances are with an income-drive repayment plan, your monthly payment plan may be less than what you have been paying. With that being said, you may end up paying more interest than with a Standard Repayment plan, and the life of your loan may be extended up to a 20- or 25-year term. The longer you spend in repayment, the more you will typically pay in total. But these trade-offs may be worth it to preserve your credit status.
•Deferment or Forbearance
You can ask that your loan be placed in forbearance or deferment. If granted there will be a temporary postponement of payments. This postponement is not permanent, interest will continue to accrue, and unpaid interest will capitalize once you reenter repayment of the loan.
o Deferment is when your obligation to repay the student loan is temporarily suspended. Subsidized federal student loans, such as the Perkins Loan and the Direct Subsidized Loan, the federal government will pay the interest during a deferment. There are very specific reasons why you could qualify for a deferment, like Economic Hardship and Unemployment. There are also time limits on how many months you can use a deferment, it’s typically three years. Talk with your student loan servicer for more information of your deferment options and eligibility.
o Forbearance is when you are asking for a temporary suspension of payment, or a reduced-payment forbearance option. Servicers may offer a forbearance option if you don’t qualify for a deferment option. Forbearance is intended to help borrowers avoid default when they are willing but unable to repay their loan due to poor health, financial hardship, or other eligible reason.
Refinance your Student Loans
One way to change the terms of your student loan is to refinance the loan. You can refinance federal and private student loans. However, a private student loan refinance will require you to qualify for the loan with a private lender—which essentially means a credit check. If you are struggling to repay your debt and your credit has been negatively impacted, you may not be eligible to refinance without a cosigner. Generally, private student loan refinance lenders will look for a credit score of at least 660, two years of work history, and they will review your debt-to-income ratio. If you can qualify, student loans can be refinanced to potentially access lower interest rates or change repayment terms should your student loan become too much of burden to pay.
If you are a federal student loan borrower, you may not want to lose the benefits provided with federal student loans. This may lead you to consider a federal Direct Consolidation Loan, thus merging all your federal student loans into one. If you consolidate your federal student loans with a Direct Consolidation Loan, you may be able to lower your payment and extend your repayment term to up to 30 years, depending on the amount of existing student loan debt you have. While this may ease your present debt burden, it could end up costing more overall.
More >>> How to Refinance Student Loans