Are Student Loans Impacting Your Credit Score?May 6, 2020
Even if you only have a basic knowledge of how credit scores are calculated, you may be aware of the fact that taking on debt and then paying it off in a timely and consistent manner is generally considered one of the best ways to build good credit, while late and missed payments can show up as black marks on your credit history. What you might not know is that different types of debt can have different ramifications where your credit is concerned.
For example, the balances carried on credit cards are considered to be a form of revolving credit, according to Investopedia. Lines of credit also fall into this category. This type of debt includes a maximum limit and accounts are considered “open-ended”, which is to say, you still have access to agreed-upon funds even after you’ve borrowed and paid back up to the maximum.
Then there are installment credit accounts, including loans for houses, cars, and college tuition, just for example, which Investopedia characterizes as separate from revolving credit in that there are terms attached which specify the duration for payments, the number and amount of payments, and an end date for the loan. Further, once payments are made, the money cannot be borrowed again.
These types of debt affect your credit score in different ways. Revolving debt is potentially more damaging, as carrying high balances on credit cards could have an enormous impact on your credit score. Revolving credit determines 30% of your score, according to MyFICO, although there are certainly other factors involved, including:
- What is owed on all accounts
- What is owed on different types of accounts
- The number of accounts with balances
- The percentage of revolving credit in use (credit utilization ratio)
- The amount still owed on installment loans
Of course, if you find that revolving credit is severely impacting your credit score, Investopedia suggests that paying it down also has the potential to deliver significant improvements, and some people even utilize installment credit (personal loans) to pay off revolving credit as a means of lowering interest rates and shifting to a less impactful form of debt.
Although revolving credit accounts for a major portion of your credit score, installment loans can also have an impact in both positive and negative ways, according to an article from Student Loan Hero. Here’s what you need to know about how student loans can impact your credit score.
How Can Student Loans Help Credit?
Because installment loans aren’t weighted as heavily as revolving credit when determining credit score, they may have less potential to damage your rating. In fact, FICO statistics show that approximately 38% of consumers with student loan debt totaling over $50,000 fall enjoy a FICO score of over 700, which is considered the average score for American consumers, according to a recent article by Fox Business. Those in the 740-799 range are considered to have very good credit, while a score of 800 or higher is considered exceptional. By comparison, about 28% of consumers with student loan debt over $50,000 have scores under 599, which is considered a poor credit rating.
What does this mean? It’s difficult to say, because credit ratings are based on so many different factors aside from student loan debt. However, when managed appropriately, student loans, like any type of installment loans, could certainly improve a credit rating.
While revolving credit accounts for 30% of a credit rating, payment history is actually more important, delivering a whopping 35% of your credit score. If you pay your monthly student loan bills on time and in full, you should be able to steadily build good credit over time, especially when you take the same care with all your other financial obligations. Of course, this can be a double-edged sword, as well.
How Can Student Loans Hurt Credit?
While student loans don’t necessarily have the same major detractors as revolving credit, they still have the potential to harm your score if you don’t manage them appropriately, and even a single slip could cost you.
Even if you’re a responsible adult and you’re diligently paying down debt, it can be hard to juggle the many student loan payments associated with years of schooling (and taking out new federal student loans each year). Something could slip through the cracks. When this happens, it could have a negative impact on your credit score.
Even worse, the better your credit score, the more a late or missed payment could impact you, according to MyFICO. This is because a higher score reflects less risk. While a consumer with a lower FICO score is known to have some credit issues and is therefore somewhat less impacted by future problems like late or missed payments, someone with a stellar credit rating may fall further for similar infractions because the risk was not anticipated. It doesn’t seem fair, but it’s important to understand the potential credit impacts of paying off student loan debt.
Why Does the Impact of Student Loans Matter?
Your credit score is used to determine whether you are approved for future loans and to calculate the interest rate and terms you are eligible for, according to Student Loan Hero. While a single late or missed payment isn’t going to tank your score, and you can always speak with lenders about removing black marks on your credit report once you’ve rectified a mistake, you naturally want to maintain a high score if at all possible so as to improve your odds for loan approval and the best terms down the road.
How Can I Improve My Credit Score While Paying Off Student Loans?
Even if you’ve had smooth sailing so far, you may be interested in the benefits to be gained when you refinance student loans.* If you currently juggle several student loans and you’re worried about the possibility of missing a payment somewhere along the line, you could refinance and consolidate student loans into one convenient payment.
In some cases, you might even save money when you refinance student loans by lowering interest rates or transferring variable interest loans to fixed interest options. It depends on your situation, but it’s something to consider when it comes to controlling how student loans impact your credit score.