If you have federal student loans, you may have until May 1, 2022 due to the current federal student loan payment freeze.
But just because you don’t make payments now doesn’t mean your student loans aren’t paying off. Your student loans can have a major impact on your credit score and financial life. Whether this effect is positive or negative depends on what you do after resuming payments.
Although student loans are often considered “good debt” — debt that can improve your life in meaningful, long-term ways — it’s still debt that can hurt your financial future.
“Student loans can help or hurt your credit score, just like any other type of credit obligation that shows up on your credit report”, says Michelle Lambright Black, credit expert and founder of CreditWriter.com. For example, paying your student loans on time can improve your credit score over time. At the same time, she added, late payments could lead to a drop in your credit score.
But as long as you make your payments on time, student loans can help your credit score more than hurt it. Here’s how student loans can affect your credit score — and how you can use them to your advantage.
How do student loans affect your credit score?
Your credit score is usually calculated based on five main factors: payment history, credit utilization (balance owed divided by total available balance), age of your credit history, your credit portfolio, and recent hard credit requests.
According to Mark Kantrowitz, a college expert and author of How to Appeal for More College Financial Aid, your student loans affect your credit score primarily through your payment history. Payment history accounts for the largest portion of your credit score, so late or missed student loan payments can have a considerable impact on your credit score.
“Late payments can reduce your credit score by 50 to 100 points,” Kantrowitz said. “Student loan defaults that occur after 120 days of default on private student loans and 270 to 360 days after default on government student loans can have a bigger impact on your credit score.”
Because student loans are instalment loans, credit utilization is less important than revolving accounts like credit cards, Kantrowitz explained. However, having an installment loan in your loan portfolio, especially one that helps build a longer credit history, can help your overall credit score.
Both Black and Kantrowitz say personal and government loans affect your credit score in similar ways. “From a credit standpoint, there is no difference between federal student loans and private student loans,” Black said.
It’s important to note that your credit score isn’t the only part of student loans that can affect your finances, Kantrowitz said. They also affect your debt-to-income ratio, making it harder for you to qualify for a mortgage. However, Kantrowitz said recent changes to mortgage underwriting rules for certain federally-backed loans mean borrowers with income-based repayment plans may find it easier to get a mortgage than before.
Will my credit score get worse if I miss my monthly payment?
Due to the importance of payment history, any missed student loan – private or state – can have a significant negative impact on your credit score.
However, Black warned that your private lender or federal trustee must report you as “late” before the action affects your loan. “For private lenders, that’s what happens if you’re past the 30-day past due period,” explains Black. “By contrast, federal student loan agencies typically don’t report you to credit bureaus until you’re 90 days past due.”
Even if you are not reported, you may still face negative consequences from your lender or service provider, namely late fees or penalties. These can increase your loan balance and generate more interest, increasing your debt. Therefore, it is very important to pay on time as much as possible.
Even after you resume payments and renew your account, late payments can remain on your credit report for up to two years, Kantrowitz said. “However, recent activity has had a greater impact on your credit score than previous activity,” he added. “As a result, your credit score should improve even in the months after you update your account and resume payments.”
Can Student Loans Help Improve Your Credit Score?
While missing student loan payments can hurt your credit score, making consistent and on-time payments helps build a positive payment history, Black said.
If you have a thin credit file, adding another account to your credit report can also help, Black adds. Student loans can improve your credit portfolio and account for 10% of your FICO score calculation. A good credit portfolio can improve your credit score and show lenders that you can handle many types of credit.
Over time, your student loans get “older” and the average age of your credit accounts goes up, which can also give your credit score a boost.
Of course, it all depends on making regular and on-time payments. Kantrowitz recommends setting up AutoPay with your private lender or federal loan servicer. That way, you don’t have to remember to make your repayments every month, and it reduces the chance of ending up late on a payment or worse, missing a payment entirely.
“Not only are you less likely to default on your repayments, but if you sign up for AutoPay, many lenders will lower your interest rate,” Kantrowitz said. “Typically, you would see a 0.25 or 0.50 percentage point reduction as an incentive. .”
Will Student Loans Affect Credit Scores During a Student Loan Freeze?
Payments on federal student loans have been frozen as part of the federal government’s pandemic relief measures. During this period, certain loans do not have to be paid and do not accrue interest. In addition, the collection of delinquent loans has been suspended. The last extension to this payment freeze will expire on May 1, 2022. While there may be additional renewals in the future, don’t rely on them to plan ahead.
During the lockdown period, you will not be penalized for non-payment, which means your credit score will not be affected. However, if your loan defaults before the freeze, it can still show up on your credit report and affect your credit score even after collection attempts stop.
It is worth noting that not all loans will be affected by this freeze. Private student loans are not affected. Additionally, non-default loans from FFEL programs that are not held by the Department of Education are not eligible.
Whether you have government or private student loans, it’s important to address repayments early. Borrowers in financial difficulty should contact their loan servicer and ask about their options rather than default on their loan, Kantrowitz said. These options may include forbearance and forbearance, partial forbearance, reduced interest payments, and alternative repayment plans.
Ultimately, the best way to keep your credit score healthy and keep your debt under control is to stay on top of your student loan payments—whether it’s paying the amount due each month on time, or contacting your lender as soon as possible and looking for alternatives to agree to if you can’t make payments.