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Understanding Credit

Education costs seem like they’re constantly on the rise. As a result, more and more people are borrowing money for college. Recent statistics show that approximately 43 million people have outstanding federal student loans, totaling $1.6 trillion. In addition, millions of private student loans total more than $136 billion. While student loan debt is almost a given if you’re seeking a college degree, how do student loans affect your credit score?

Before diving in, let’s review the different types of student loans. A federal student loan is funded by the U.S. government and is subject to federal guidelines. These loans will have better interest rates and repayment plans than what is typically available from private loans. A private student loan is made by a bank, credit union, or state-based lending organization. Loan terms and conditions are determined by the lender. Private loans aren’t subject to the same mandates and caps as federal loans, so they’re usually more expensive. 

Now that we have identified the different kinds of student loans, let’s break down how they may affect your credit score. Your FICO® credit score is based on 5 basic factors. In this article, we’ll explore each and how it relates to a student loan.

Payment history

Payment history is the biggest factor when calculating credit scores. Paying your bills on time accounts for up to 35% of your total score, and negative marks may stay on your record for 7 years. Making on-time payments to your bills—including your student loan, other installment loans, and credit cards—will likely improve your score. 

If you’re late making payments or miss a monthly payment, your loan servicer will notify the 3 major credit bureaus, and your score could drop. The further past due your payment is, the more you could be penalized. However, there’s good news! If you have a late or missed payment, bringing your account to current could help. After you’ve kept your account current for a while, the on-time payments will outweigh the late payments, and your score will improve.  

With federal student loan payments, there’s generally a longer grace period related to credit bureau reporting. The federal loan servicer may wait to notify credit bureaus until your loan payment is more than 90 days late. The servicer will typically send notices and may allow payment arrangements, like an income-driven repayment plan, before it’s too late. 

In contrast, a private lender has no reporting restrictions. If you’re more than 30 days late on any installment loan, they may report it, and your score could be impacted. Another thing to keep in mind is defaulting on your loan. If you are “in default,” you haven’t made payments in a long time. That period is usually defined in your loan agreement. Private loan servicers can take immediate action to collect the debt once you are in default. Federal student loan servicers can attempt to recover your debt by suing you or garnishing your wages. All of this could affect your credit score significantly.

If you are in default or are having difficulty making your payments, it’s important that you call your lender or student loan servicer to see what kinds of payment programs are available to you.  

 Credit utilization

Credit utilization is a fancy way of saying “amount owed,” and it accounts for 30% of your credit score. The amount you owe across your credit accounts is compared with your total credit limits, and the percentage is your credit utilization. For instance, a credit card issuer might grant you a card with a $10,000 limit. If you charge a $3,000 vacation on it, that works out to a 30% utilization. Keeping it at or below 30% is recommended to maintain a healthy credit score. 

Let’s say that in addition to the credit card we just mentioned, you open a new loan for $20,000. You might expect your utilization ratio to skyrocket. Fortunately, the credit bureaus only consider your revolving credit, like credit cards or store credit accounts, when determining your score. So, your student loan has no effect on this part of your score.

Something to note: Your credit utilization ratio is different from your debt-to-income ratio (DTI). Lenders use DTI to figure out how much money remains in your pocket every month after you pay your bills. Need a new auto loan or credit card? The more money you have left over at the end of the month, the better your chances for approval could be.

Credit history

Your credit report contains your account history, and this part of the score reflects the overall age of your accounts. The history of all your revolving credit and other loans makes up 15% of your credit score. Because they are long-term loans and stay on your record for quite a while, student loans could positively impact your score if you make your monthly payments on time.

Credit mix

Credit mix accounts for 10% of your credit score and looks at all the types of credit you carry. This includes lines of credit, revolving accounts, mortgages, and other installment loans. A good credit mix can have a positive effect on your score. The downside is that once your student loan is paid off, your credit score may decrease due to a reduced credit mix. 

New credit

This part of the score accounts for 10% of the total and is based on new credit that you take on. Opening multiple new accounts around the same time may knock down your score a few points. Also, a new loan reduces the credit history part of your score by lowering the average age of your credit. To maintain good credit, avoid accepting any new credit for 6 months to a year after starting a new loan. Simply applying for credit could decrease your score if lenders do a hard credit check. 

Checking your credit report 

Everyone with a loan or credit account should check their credit reports regularly. You can review your credit report for free at Best Egg Financial Health. Go over it in detail and check for inaccuracies and any negative information. Report errors to whichever credit reporting bureau is responsible. They are required to investigate and report their findings. Plus, they’ll send you an updated report for free. If you find an error in one credit report, check your reports from the other 2 credit bureaus.

It’s important to keep your credit accounts current. Staying on top of your finances before anything gets out of hand is a smart way to build financial confidence. Be sure to keep up with your student loans as much as possible until you’ve finally paid them off, so that it does not affect your credit score.

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.


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