Chris Bridges, Founder and CEO, VITAL Card Inc.
The last thing you want to consider when you’re a student is how your loans will impact your credit. But for financial literacy, it’s essential to understand how a student loan can affect your credit score, both in the short and long term.
Fortunately, the three major credit bureaus — Experian, TransUnion, and Equifax — generally view student loans as good debt, which is an investment in your future. Plus, this type of loan can help you build credit and establish a good credit history when you make monthly on-time payments.
What Are the Different Types of Student Loans?
College students take out two main types of loans to fund their education: federal student loans and private student loans. Issued by the U.S. Department of Education, federal student loans often carry a fixed interest rate, and they can be subsidized or unsubsidized.
With subsidized loans, the government pays the interest charges while you’re enrolled at least half-time in school and during grace or deferment periods. In contrast, borrowers who take out unsubsidized loans have to pay for the interest that accrues while they’re in school, in addition to the interest that accrues after.
But there is a third option. Private student loans may have either variable or fixed interest rates, with creditors that can include banks, credit unions, and other financial institutions. Subsidized federal student loans tend to allow for more favorable terms than private loans—so if you need a student loan and qualify for subsidized federal loans, that should be the first place you look.
For example, federal student loan interest rates are usually lower than private ones, often with more flexible repayment methods, such as deferment and forbearance options. If a federal student loan borrower is experiencing financial hardship, she can request a deferment or forbearance, which allows borrowers to stop making payments or temporarily reduce their monthly payment amount.
Private loan servicers may or may not extend these same forms of borrower protections that federal lenders provide, but it depends on the specific creditor and the student loan terms.
How Does a Student Loan Affect Your Credit Score?
A credit score numerically represents a borrower’s creditworthiness. Generally, a higher score indicates to lenders that you’re a lower-risk borrower, which could lead to better loan terms and interest rates.
The score can also affect your ability to qualify for certain types of loans, such as a mortgage or car loan. In the world of personal finance, there are several different credit scoring models, with FICO Scores and VantageScore being popular among most lenders.
So, how does a student loan affect your credit score? Typically, a student loan will appear on your credit report as an installment loan. This type of loan requires a borrower to make monthly fixed payments over a set period.
Installment loans can potentially increase your credit score if you make your payments on time each month, allowing you to build a strong credit history. Conversely, late or missed payments may hurt your score.
In addition, student loans can impact your credit mix, which credit scoring models take into account when determining an individual’s score. A good credit mix includes different types of credit, such as auto loans, student debt, and credit cards.
Overall, having a student loan can improve your credit score if you make timely payments and keep up with the terms of the loan agreement.
What Happens If You’re Late or Miss a Payment on Your Student Loans?
Making timely payments on your student loans is crucial to maintaining a good credit score. When borrowers are behind on their student loan payments or miss a payment altogether, this can adversely impact their credit score if the loan servicer reports it to the credit bureaus.
Referred to as a delinquency, this could mar your credit report for up to seven years, and late fees could also apply. The good news is that lenders typically do not inform credit reporting agencies about overdue payments immediately.
For federal student loan borrowers, it may take 90 days or more for their lender to file a report about late or missed payments. In contrast, private student loan servicers usually report delinquencies to the credit bureaus after a month.
Failing to make a payment after 270 days could lead to a default on the loan, and the debt may go to collections. A default is generally more damaging to a credit score than a delinquency lasting one to three months. Plus, the negative mark could stay on your credit reports for up to seven years.
How To Manage Your Student Loan Payments
If you’re like most college graduates, you have some student debt. And if you’re like most people with debt, you likely want to get rid of it as soon as possible. But where do you start?
The first step is to determine when your repayment period begins. This will allow you to be prepared when the time comes and allocate funds accordingly.
Next, create a budget. Figure out how much money you have coming in each month and how much your fixed expenses are, such as your monthly rent or car payment.
Then review your variable expenses and see where you can cut back. For example, people in the process of paying down debt may choose to dine out less frequently or spend less on entertainment.
After you have your budget figured out, establish a plan for paying off your student loans and any high-interest debt, such as credit card debt. Consider setting up automatic payments from your bank account or credit card to ensure you never miss a payment, especially since late payments can negatively impact your credit score.
In addition, make extra payments when you can. Even if you can only afford to make a small additional payment, every little bit helps. You can save money on interest and potentially pay off your loan faster.
When Do You Have To Start Repaying Your Student Loan?
Generally, borrowers taking out federal student loans don’t have to start repaying them until after they graduate, withdraw from school, or drop below half-time enrollment. And they can repay their loan at any time without penalty.
When it comes to a private student loan, a borrower may or may not have to start repaying his loan as soon as the money is disbursed. If you do and you’re not able to immediately begin making student loan payments, contact your lender as quickly as possible. They may be able to work with you to create a more manageable payment plan.
Borrowers may also consider refinancing their student loans, especially if a private lender fails to offer options to defer payments. The student loan refinancing process involves taking out a new loan, which may have a lower interest rate or a more favorable repayment schedule, to stay on top of payments and pay off one or more existing loans.
How Can You Pay Off Federal Loans on a Limited Income?
From the Standard Repayment Plan to income-contingent repayment models, there are several ways for borrowers to afford their federal student loan payments. Plus, some borrowers may even qualify for a student loan forgiveness program if they meet the eligibility requirements.
Check out a few of the most common approaches to federal loan repayment:
- The Standard Repayment Plan is the general repayment plan for federal student loans. Under this model, your monthly payments typically consist of a fixed amount over 10 years.
- The Graduated Repayment Plan allows for lower initial payments that gradually increase over time, often every 48 months. This repayment plan also has a term of 10 years.
- The Extended Repayment Plan stretches the repayment period up to a maximum of 25 years, depending on the loan amount. Though this results in lower monthly payments, you may have to pay more interest over the loan’s length.
- The Income-Based Repayment Plan (IBR) and Pay As You Earn (PAYE) are income-driven repayment plans that determine your monthly payment based on a percentage of your discretionary income, usually 10 percent. After a borrower makes payments for 20 years, the remaining loan amount is canceled.
- The Public Service Loan Forgiveness Program (PSLF) is an incentive for employees in the public sector, such as government organizations or nonprofits. After making 120 qualifying monthly payments, full-time public service workers can have the rest of their loan balance forgiven.
If you are having trouble paying your monthly student loan bill, these repayment plans and student loan forgiveness options could be worth looking into as a way to make your personal finances more manageable.
The Bottom Line on Student Loans and Your Credit Score
When it comes to your credit score, student loans are similar to other types of credit that require installment payments, such as auto loans or personal loans. Student loans can also help build your credit score — if you make your payments on time.
This is why it’s crucial to stay on top of your payments and make sure you can repay your loan in full. Ultimately, if you manage student loans responsibly, your credit score may improve in the long run.
If you’re looking for a way to learn about credit that can also support your credit health, VITAL Card might be a good fit. With options that can earn you cashback for spending, credit health resources, and a unique structure that rewards you for sharing and spending responsibly, take some time to see if VITAL is right for you.
The Standard Repayment Plan is the basic repayment plan for loans from the William D. Ford Federal Direct Loan (Direct Loan) Program and Federal Family Education Loan (FFEL) Program | Federal Student Aid
VITAL Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.