- Most federal student loans don’t require a credit check, which can affect your credit score; all private student lenders will run one.
- Your loan balance and monthly payment can impact your credit score and ability to take on more debt.
- Paying on time is crucial to using your student loans to build credit.
- Take care to avoid pitfalls that could damage your credit for several years.
Student loans can be helpful and, in some cases, necessary for paying for college. But as a young person, they can also be instrumental in helping you build your credit history. “Paying off student loans can positively impact someone’s credit history,” says L.J. Jones, a financial planner at Developing Finance, a financial planning firm. At the same time, not paying your loans on time could damage your credit score.
The FICO credit score, which is the most widely used score by top lenders, ranges from 300 to 850, and a score of 670 or above is considered good. A good credit score matters because it can help you secure financing at lower interest rates and sometimes with fewer fees. It can also help you save money on auto and homeowners insurance and even make it easier to lease a place to live and get certain jobs.
President Biden gave student loan borrowers a helping hand recently by instituting the Fresh Start initiative, which returns borrowers who were delinquent or in default prior to the pandemic to a current status when repayment restarts, and remove the delinquencies and defaults from their credit history.
But there are plenty of ways that your student loans can affect your credit score. Here’s a look.
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Applying for the loan
Most federal student loans don’t require a credit check, which means you don’t have to worry about a hard inquiry on your credit report (more on this in a bit). In contrast, if you apply for a loan with a private lender, you’ll typically undergo a credit check.
The hard inquiry associated with this check typically takes fewer than five points off your credit score, if at all. And the impact is not permanent—hard inquiries only affect your FICO credit score for 12 months. Additionally, if you’re rate shopping for private student loans or refinance loans, FICO generally combines those multiple inquiries into one for scoring purposes, as long as you complete your comparison process within 14 or 45 days, depending on the scoring model.
Finally, keep in mind that many private student loan companies allow you to get prequalified with just a soft credit check, which won’t impact your credit score. However, the rate quote you get is dependent on a hard inquiry and your application.
Monthly payments on your loan
Your payment history is the most influential factor in your FICO credit score, so making on-time payments on your loans is paramount once you’ve entered the repayment process after graduation. If you miss a payment by 90 days on federal loans or 30 days on private loans, you’ll get a negative mark on your credit reports. Those late payments will remain on your credit reports for seven years and impact your credit score during that time.[2,3]
Of course, you don’t have to worry about that if you’re still in school. “For FICO credit scores, loans in deferment do not impact your credit score,” says Jones. “So not making payments in school does not negatively affect your credit score.”
That said, if you can afford to pay at least the accrued interest on your loans while you’re in school, those payments will be reported to the credit bureaus, which will help your credit score because they count as on-time payments. What’s more, you can avoid interest capitalization, which adds all of the interest that accrues while you’re in school to your principal balance.
Loan and payment amounts
How much you owe can impact your credit score, though it’s unclear exactly by how much. The key is that if you have a lot of debt, your risk of defaulting increases if you take on new debt. While your monthly payment amounts won’t directly affect your score, they will impact your ability to get credit in the future.
One of the factors lenders consider when you apply for credit is your debt-to-income ratio, which is the percentage of your monthly income that goes toward debt payments. This won’t impact your credit score directly, but a high student loan payment could still make it challenging to buy a home and obtain financing for other large purchases.
Paying off the loan
When you pay off a student loan or consolidate or refinance your existing loans, you may notice a dip in your credit score. This is because data suggest that having fewer loans on your credit reports can pose a higher risk to lenders than having loans, even if the balance is low.
Paying off your student loans could also impact the mix of credit that you have, which is another major factor in calculating your credit score. “Having installment loans like student debt is different from revolving credit like a credit card,” says Jones. “Once student loans are paid off, someone may be negatively affected because now 100% of their debt may only be for credit cards.”
That said, paying off your student loans will provide significant financial benefits, including a lower debt-to-income ratio and more cash flow, and as long as you use credit responsibly in other ways, the decrease will likely be temporary.
Other ways student loans can affect credit scores
There are many other scenarios that you may come across with your student loans. Here’s how they may or may not impact your credit score:
Loan deferment or forbearance: Since you’re not obligated to make payments, this won’t impact your credit score.
Federal loan consolidation: If you want to consolidate your federal student loans through the U.S. Department of Education, there’s no credit check involved. Also, your loan balance stays the same, so there will be no impact on your credit score from that perspective. But because you’re replacing multiple loans with one new loan and you’re creating a new credit account, there can be a slight impact on your score.
Student loan forgiveness or repayment: If your loans are paid in full through a forgiveness program or a student loan repayment assistance program, the loan will be reported as paid off, which typically affects your credit score positively.
Student loan refinancing: If you refinance your loans with a private lender, there will be a hard inquiry involved when you apply. The other potential impacts on your credit score are the same as the federal loan consolidation process.
As you better understand how your student loans can affect your credit score, the important thing is to always pay on time and to monitor your credit regularly to track your progress and to address potential issues as they arise.