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Updated 10/2023: Credit scores will not be affected by non-payment in the first 12 months – loan repayments will resume this month.
As a young person just out of college, you may be wondering how student loans impact your credit? Well, the impact of these loans can be positive or negative. It all depends on how you handle loan repayment.
While in college, loans can be very helpful, but after graduation, everything changes. Missed repayments will start to eat away at your financial life. On the other hand, timely repayments will allow you to achieve greater financial freedom. To learn more, here’s how student loans affect your credit.
The positive effects
– They give you a long credit history
The length of your credit history as well as the average age of your account are some of the elements that impact your credit score. The length of your credit history has a 15% influence on your score.
With student loans having payment schedules extending up to 10 years, your score will definitely improve if you make the required payments. However, you should aim to repay the loans in a shorter period of time to reduce the interest payable.
– Making monthly payments on time will increase your score
Your payment history on student loans accounts for 35% of your score. If your payments are made on time and the required minimum is met, your score will skyrocket.
For better scores, pay more than the minimum monthly payment. Think of it as a forward payment, allowing you to benefit from lower rates on future loans like mortgages.
– Student loans can help you build your credit score
For many young people fresh out of school, student loans help you open your credit file. This information will be used by credit bureaus to evaluate you. This will prevent you from joining the millions of people who are “credit invisible”.
Without this file or data, creditors will not have a basis on which to evaluate your creditworthiness. You might end up paying more for rent, car rates, etc.
– Student loans help you establish your credit mix
Credit mix refers to the different lines of credit you take out over time, such as car loans, credit cards, and mortgages, among others. A healthy credit mix is very good for your credit; 10% of your credit score will be judged there.
– Late payments damage your credit
Late payments are reported to credit reporting agencies and will remain on your report for at least 7 years. This will lower your credit score. Additionally, they will incur late fees from your loan servicer. If you have multiple loans with the same creditor, defaulting on one loan will negatively impact all loans.
Keep in mind that with President Biden’s student loan payment pause, payments and interest on student loans have been suspended until August 31, 2022 (Update: Student loan repayment resumes in October 2023.) This does not mean that the loan is canceled, however, just that there is no need to make payments at this time.
Student loans can also put you under financial pressure. This can lead to late payments on other loans such as credit cards, further ruining your score.
– Failure to pay can reduce your access to credit
For lenders, late payers are tolerable compared to defaulters. Defaulters cause creditors to lose money. As someone paying a student loan, you should never default.
For a missed payment to be considered delinquent, it must last more than 270 days. After this time, the full amount of your student loan will now be due. A default stays on your credit report for 7 years from the date of default.
What does that mean? For 7 years, your chances of accessing credit will be very low. No creditor will want to take a risk with you. You should never allow your account to be in collections.
– High balances will increase your DTI
It’s difficult to get approved for new credit if you have high balances on an existing loan. This all has to do with your debt-to-income ratio (DTI), which is the portion of your total monthly income that goes toward paying off your debts.
If your debt-to-income ratio is high, it shows that you are not very committed to resolving your situation and that creditors are avoiding you. Additionally, DTI has a 30% influence on your credit score.
This will make buying a home almost impossible, especially given the current real estate market. With the shortage of supply, property prices have reached record highs, while interest rates have soared, causing banks to become very strict on DTI ratios when approving mortgage loans.
Fortunately, when it comes to creditworthiness, the influence of installment loans such as student loans is not as strong as that of revolving credit. If you have mismanaged your student loans in the past, you may be able to remove some negative items from your credit report. However, it is important to make an effort to repay the loan, as it will only disappear when you die. Additionally, by offsetting these loans, their negative impact on your credit score will begin to fade over time.