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How Student Loans Affect Your Credit
Whether you’re making your payments on time, paying extra every month, or struggling to pay the debt, student loans impact your credit report and score – for the good and the bad.
Accentuate the Negative
Any time you fail to make a student loan payment on time, this is going to have a negative impact on your credit. Your payment history is 35% of what makes up your credit score, according to FICO, so late payments won’t look good.
But making your student loan payments on time every month can strengthen your credit. You’re showing that you’re managing your debt correctly and are able to pay your loan as agreed. Student loans are often treated as installment plans on your credit report.
According to Equifax, student loans are often viewed as “good debt,” since it’s an investment in something that will build value (you hope).
But if you have a high debt-to-income ratio, this could be bad for your credit. If you’re in a low-paying job with a high amount of student loan debt, this could hurt your credit.
Student loans can also negatively affect your credit if you have a high balance that isn’t budging or, with interest, possibly even growing.
Does a Student Loan Deferment Affect Your Credit?
A loan deferment, in which payments are temporarily postponed, might hurt your credit. Or it might not. That’s because each person, each loan, and each credit report is a different story.
Loans that are unsubsidized, with interest, can grow during a deferment. A growing student loan debt can deter a lender, such as for a mortgage, from loaning to you, according to Money Crashers.
But according to U.S. News, a deferment can improve your chances of being approved, since the lender sees you aren’t required to make payments toward your loans at that time.
In any situation, putting a loan in deferment is better than not making payments. Deferments aren’t an option for every loan or every situation, but if you’re experiencing an economic hardship, it’s something to explore. Another thing to note about deferments and loan repayment is that if your student loan becomes delinquent, you may no longer be eligible for a deferment.
Best Way to Improve My Credit?
Surprise! Another gray area is upon us.
Working hard, making extra payments, and paying off your student loan balance will help your credit, right? In some cases, it doesn’t.
Paying off your student loans too quickly can actually bring your score down, according to AllTuition.com. Once your loan is gone, you’re no longer making those monthly payments on time, thus ending your positive payment history on your credit report.
A Huffington Post article explains that yet another way in which paying off your student loans can damage your credit is by reducing the type of credit you have. Having multiple types of credit, such as a loan and credit cards, can improve your credit. Once your loan is paid off, you’re eliminating that type of credit.
However, the types of credit you have only constitute 10% of your score, whereas the total amount you owe counts for 30%. So keeping that big student loan balance around, especially with a lower income ratio, is going to hurt you.
So even though it could lower your score initially, keep in mind that paying off a student loan earlier means you’ll pay less in interest overall. It’s also going to decrease your debt-to-income ratio.
How Does Consolidating Student Loans Impact Your Credit?
There are many pros and cons of student loan consolidation.
On one hand, consolidation could make managing your loans easier by only paying one lender each month, potentially lowering your monthly payment, and even having a chance to lower your interest rate depending on any credit improvements since you took out the loan.
On the other hand, consolidating could mean you lose certain borrower benefits (e.g., student loan forgiveness, deferments, flexible payment plans), lengthen your repayment period, and even end up paying more over time.
But does it negatively or positively affect your credit? Just like the other issues, it depends on your situation. As always, research the options but consider what is going to be best for you.
Student loan consolidation can negatively affect your credit because, just like applying for any other type of loan, it’s going to show as a hard inquiry on your credit history. According to Equifax, this “ding” can lower your score by a “couple of points,” which remains on your credit report for two years. Also, opening a new account will lower your average account age, which makes up about 7% of your credit score.
Opening this new consolidated loan means you’re now “closing” those pre-existing loans. This will lower your average account age and show a reduction in that account history.
However, consider that if consolidating your loans means a lower payment, making it easier to make monthly payments on time, this will help your credit. Also, if you’re able to qualify for a lower interest rate on this consolidated loan, you’ll pay less over time.
What If You Stop Paying Your Student Loans?
Approximately 22% of borrowers are unable to pay their loans, according to The Wall Street Journal, which notes that these borrowers have loans that are either in forbearance or, much worse, in default.
Not only will ignoring your student loans ruin your credit, but it will have a slew of other negative results on your life. And you’re not the only one affected. If you had a parent or relative nice enough to co-sign your loan, non-payment will hurt their credit, too.
If you miss one student loan payment, even by a day, your loan will be considered delinquent. According to the U.S. Department of Education, loan services will report your delinquency of 90 days to the three major credit bureaus.
If you don’t make a payment on a federal loan for 270 days, your loan is considered in default. But for private lenders, that default could be far less time — even one missed payment, depending on the lender.
Having a loan in default is going to be a huge red flag to possible lenders, not to mention to landlords when trying to rent an apartment, utility companies, or even a potential employer in some cases. Defaults stay on credit reports forever until you pay the loan in its entirety, according to Money Crashers.
Default also means you could be ineligible for any future financial aid or loan benefits, such as applying for a deferment or student loan forgiveness. Also, depending on your lender, if you go into default, your wages could be garnished for federal loans, you may not get a tax refund, and you could be dealing with collection agencies.
Private lenders can’t garnish your wages like the government, but they can sue to get their money, along with turning your loans over to collection agencies. Plus, loans in default are still accruing interest, so they’re only getting bigger each month.
Explore every possible option before defaulting on your loans. Depending on your lender and loan details, apply for a deferment or an income-based repayment plan. If those options aren’t available to you, at least contact your lender to see if they are willing to offer you a payment plan.
You can also consider various types of student loan forgiveness, including finding a job that pays your loans, volunteering to put money toward your loans, joining the military, or moving to a place that pays your loans. You’ll want to thoroughly research each of these options before you sign a contract or make a major life decision.
Action Items: Student Loans and Good Credit
Always pay your student loans on time. Consider signing up for auto-repayment if offered, which can help you pay your bill when it’s due. Plus, some lenders offer a small interest-rate reduction if you enroll in automatic payments from your checking account. If you opt for auto-debit, be certain you have sufficient funds in your account.
If auto-payments aren’t an option, do whatever you need to do to remember to pay that bill on time. On-time payments are the best thing you can do for your credit. Sign up for e-mail alerts, text alerts, set a reminder on your phone, and write it on your calendar.
Keep all of your contact information up to date. During your college years and afterward, there’s a good chance you’re changing addresses, e-mail addresses, and phone numbers. Update this information often so you’re getting your bills and any notices. Check your spam folder, and adjust your e-mail filters so you’re getting notices from your lenders.
Keep track of your loans. Unfortunately, many people lose track of all the loans they took out in college. There are more than a few cases where people have a loan in default that they don’t even know exists. Start by visiting the National Student Loan Data System to help track your loans.
If you can’t make payments, explore other options such as income-based repayment, a deferment, working with your lender on a payment plan, or exploring student loan forgiveness. Avoid late payments and loans going into default at all costs.
Make it a point to check your credit report from each of the three credit reporting agencies – Experian, Equifax, and TransUnion — once per year (so a total of three times). This way you can confirm that your positive payment history and balance are accurately reported by your student loan lenders. It’s also a good way to triple-check that there isn’t a loan you forgot about.