If you have federal student loans, you may not have to make payments until May 1, 2022, thanks to the current federal student loan payment freeze.
But just because you’re not making payments now doesn’t mean your student loans don’t matter. Your student loans can have a major impact on your credit score and your financial life. Whether this impact is positive or negative will depend on what you do once payments resume.
Although student loans are generally considered “good debt” – debt that can potentially improve your life significantly and in the long run – they are still debt and can affect your financial future.
“Student loans can help or hurt your credit score, just like any other kind of credit obligation that shows up on your credit report,” says Michelle Lambright Black, credit expert and founder of CreditWriter.com. “For example, timely payments on student loans could boost your credit score over time. Late payments, on the other hand, could lead to a lower credit rating,” she adds.
As long as you make payments on time, however, student loans are more likely to improve your credit score than hurt it. Here’s what to know about how student loans affect your credit score and how you can use them to your advantage.
How do student loans affect your credit score?
Your credit score is typically calculated using five main factors: payment history, credit usage (balance owed divided by total available credit), how long your credit history is, your combination of credit and recent firm credit applications.
According to Mark Kantrowitz, higher education expert and author of “How to Appeal for More College Financial Aid,” your student loans impact your credit score primarily through your payment history. Payment history makes up the largest part of your credit score, so late or missing student loan payments can have a pretty big impact on your credit score.
“Late payments can drop your credit score by 50 to 100 points,” says Kantrowitz. “Default on your student loans, which occurs after being 120 days behind on private student loans and 270 to 360 days on federal student loans, can have a greater impact on your credit score.”
Because student loans are considered installment loans, credit usage doesn’t matter as much as with revolving accounts like credit cards, Kantrowitz says. However, having an installment loan in your credit mix, especially one that helps build a longer credit history, could be helpful for your overall credit score.
Black and Kantrowitz claim that private and federal loans affect your credit similarly. “From a credit reporting perspective, there is no difference between a federal student loan and a private student loan,” says Black.
It’s important to note that your credit score isn’t the only part of your financial profile that student loans affect, Kantrowitz says. They can also affect your debt-to-income ratio, making it more difficult to qualify for a mortgage. However, recent changes to mortgage underwriting rules for certain government-backed loans mean that borrowers with an income-driven repayment plan may have an easier time qualifying for a mortgage than before. , says Kantrowitz.
Will my credit score get worse if I miss a monthly payment?
Because of the importance of payment history, every missed student loan payment – private or federal – can have a significant negative impact on your credit score.
However, Black points out, your private lender or federal agent must report you as “overdue” before the action affects your credit. “With private lenders, it can happen when you hit the 30-day overdue mark,” says Black. “Federal Student Loans Services, by comparison, typically doesn’t report you late to the credit bureaus until you’re 90 days past the due date.”
Even if you are not reported, you could still face negative consequences from your lender or servicer in the form of late fees or penalties. These can be added to your loan balance and generate additional interest, which increases your debt. That’s why it’s important to always make your payments on time, if possible.
Late payments can stay on your credit report for up to two years, Kantrowitz says, even after you resume payments and update your account. “However, recent activity has a greater impact on your credit score than older activity,” he adds. “So there should be an improvement in your credit score even a few months after updating the account and resuming payments.”
Reduce the risk of missing a loan payment by signing up for AutoPay. Many lenders even offer an interest rate reduction for signing up for AutoPay.
Can student loans help improve your credit score?
Although missing student loan payments can lower your credit score, paying regularly on time helps build a positive payment history, Black says.
Adding another account to your credit report can also help if you have a thin credit report, adds Black. Having a student loan could improve your credit mix, which accounts for 10% of your FICO score calculation. A good credit mix could boost your credit score and show lenders that you can handle multiple types of credit.
And, as time passes and your student loan ages, the average age of your credit accounts increases, which can also give you a small boost in your credit score.
Of course, it all depends on your ability to consistently make payments on time. Kantrowitz recommends setting up AutoPay with your private lender or federal loan officer. This way, you won’t have to try to remember to make your payments each month, and you reduce the risk of paying late or, worse, missing payments.
“Not only are you less likely to be late with a payment, but many lenders offer an interest rate discount when you sign up for AutoPay,” Kantrowitz says. “You typically see a 0.25 or 0.50 percentage point cut as an incentive.”
Do student loans affect credit scores during the student loan freeze?
As part of the federal government’s pandemic relief measures, federal student loan repayments have been frozen. During this period, some loans require no payment and do not earn interest. In addition to this, collections have been suspended on defaulted loans. The last extension of this payment freeze is due to expire on May 1, 2022. Although there may be additional extensions in the future, you should not rely on them when planning.
During the freeze, you won’t be penalized for not making payments, which means your credit score won’t be affected. However, if your loan was in default before the freeze, it will still show up on your credit report and impact your credit score, even if collection attempts have stopped.
It is important to note that not all loans are affected by this freeze. Private student loans are not affected. In addition, non-defaulted loans from the FFEL program that are not held by the Ministry of Education are not eligible.
Whether you have federal or private student loans, it’s important to address repayment issues as soon as possible. Borrowers who are experiencing financial difficulties should contact their loan servicer to inquire about their options rather than letting their loans go into default, Kantrowitz says. These options may include deferral and forbearance, partial forbearance, reduced interest-only payments, and alternative repayment plans.
Ultimately, the best way to keep your credit score healthy and your debt under control is to stay on top of your student loan payments – whether that means paying the amount owed on time each month, or contacting your lender as soon as possible and work out another deal if you can’t pay.