How Can Student Loans Affect Credit?

If you’ve been to college – or plan to send a child to college – you may be familiar with the concept of student loans.

According to the U.S. Department of Education’s Office of Federal Student Aid, in 2018, there are more than 42 million total federal student loan borrowers in the United States, amounting to approximately $1.4 trillion in outstanding debt.

"Sometimes classified as 'good debt,' student loans may be one way to establish credit history – if they are paid off responsibly," said Nancy Bistritz-Balkan, vice president of consumer education at Equifax. "Establishing a responsible credit history may also lead to other opportunities for vehicle loans or mortgages. But student loans are not commitments that should be entered into quickly or without doing thorough research."

Similar to other financial commitments, student loans can appear on credit reports. Since credit scores are calculated using information from credit reports, on-time payments -- and late or missed payments -- can impact credit scores.  

Here are some general facts about student loans and credit.

Student loans operate as an installment loan, like an auto loan or mortgage. With an installment loan, the borrower pays back a principal amount borrowed, usually with interest (that’s the rate you are charged to borrow the funds), over a certain time period. Once an installment loan is paid off, the account is closed – compared to revolving credit accounts, like credit card accounts, which usually remain open for future use.

Student loans impact your debt to income and debt to credit ratios. Debt to income ratio is  the amount of debt you owe divided by your income. To calculate your ratio, add up your monthly debt payments and divide them by your gross monthly income (that’s the amount of income before anything is taken out, such as taxes). 

Your debt to credit utilization ratio is the amount of credit you're using compared to the amount of credit available to you. Generally, lenders and creditors prefer lower ratios to higher ones.

If you have a student loan and you're shopping for other loans or credit, your student loan may affect your options because of its impact on both ratios. And both ratios may be factors a lender might consider in evaluating your creditworthiness, or the likelihood you'll pay back debt. 

Loans may appear on your credit reports even while deferred.  Typically, student loan payments begin once you graduate. Until then, you’re considered to be “in deferment.” But student loans may still appear on credit reports while you’re in school and before you’ve started making payments.

If possible, you may want to consider starting to make payments on student loans before you graduate, as it may reduce how much interest you’re paying overall.

In addition, after you graduate, you may be eligible for a deferment or forbearance in certain circumstances. According to the Consumer Financial Protection Bureau, a deferment is a “temporary pause to your student loan payments for specific situations such as active duty military service and reenrollment in school.” A forbearance is a “temporary postponement or reduction of your student loan payments because you are experiencing financial difficulty.”

It’s important to understand payment plans. The payment plan of your loan will determine your minimum monthly payment, so it is important to fully understand what you will owe and at what terms, what you can responsibly afford to pay, and options if you find yourself struggling to make payments.

For example, it may be possible to consolidate or refinance your loans or enter an income-driven repayment plan. Also, some private student loan services can modify loans or reduce interest rates if you’re struggling to make payments.

There are many different types of student loans that have many different rules, so before applying for or accepting a student loan, be sure review the terms carefully and understand how the repayment plan will factor into your life.

"If you accept the responsibility of student loans, it is a good idea to create a budget so that you understand your repayment plan, as well as your day-to-day expenses," said Bistritz-Balkan. 

For more information about what to know before you consider applying for a student loan, you may want to visit the Consumer Financial Protection Bureau's Paying for College site.