Contributed by: Josh Bitel
For those of us lucky enough to have entered the work force in the past few years, student loan repayment can cause a significant impact, either positive or negative, on your credit score.
Beginning to repay these loans after the precious six to nine month grace period has expired can affect your ability to obtain other credit if not handled properly. One way to find out how you’re being affected is to pull a copy of your credit report. There are three major credit reporting agencies (Experian, Equifax, and Trans Union) and you should get a copy of your credit report from each one (click here to read our blog on how to get your free annual credit report. Student loan institutions aren’t required to report information to all three bureaus, although many do, which is important to keep in mind. If you're repaying your student loans on time, these disciplined repayments will actually help your credit score. Conversely, if you are delinquent on payments or worse, default on your loans, your credit report can take a beating, potentially crippling your chances of obtaining other credit.
Credit Score Factors
Many different factors are used to determine your credit score. Some of these factors are more crucial than others. Among these critical factors are:
- Your payment history. Meaning the consistency and punctuality of payments and how long your payment history is.
- Your outstanding debt and amounts you owe on these accounts. How close your account balances are to your defined limits is also taken into consideration.
- How long you've had credit. How long specific accounts have been open, and how long it has been since you've used each account
- New credit and new inquiries. This means outstanding applications for new credit as well as additional inquiries for your credit reports, whether by institutions or yourself, can impact your credit score.
- For a deeper look at your credit score composition, check out our blog from last year.
How Student Loans Can Affect your Credit Score
If you consistently make your student loan payments on time, your credit score should not be negatively affected. A nice tip to ensure consistency is to set up an auto-pay from a bank account. Most loan institutions will allow you to set up an automatic withdraw from your bank account, eliminating the need to remember to pay each month. As an added bonus, some institutions may even offer an interest rate discount for setting this up!
Prospective creditors may look at other factors when analyzing your debt, and student loans can make this tricky. One example of this may be if you are in a lower-paying job, this makes your debt-to-income ratio unfavorable for some creditors. Another example may be your principal balances being largely unchanged in the early stages of repayment, which is common with long term repayment schedules, and some lenders may view this as a lack of paying down debt.
It is important to monitor your credit history from all three bureaus regularly. If you find that your repayment history is not being reported correctly, contact your lender to make this correction.
Suggestions to Help Reduce the Burden
Being overburdened with debt can feel suffocating, here are some suggestions to take some weight off your shoulders:
- Pay off your student loan debt as fast as possible. Doing so will help reduce your debt-to-income ratio, even if your income doesn't increase, which can make your credit score more favorable to lenders.
- If you're struggling to repay your student loans and are considering asking for forbearance, ask your lender about any other options you may have. Interest-only payments are a cheaper alternative, although they may not reduce principal.
- Ask your lender about a graduated repayment option. This means making smaller payments in the early years of the loan, with larger payments coming in the later years.
- If you're really strapped, you can explore longer term options. Much like a home, when a longer repayment term is selected, you will likely be paying more in interest over the life of the loan, but the monthly payment can be significantly reduced.
- If all else fails, don’t ignore your student loans. Generally these loans won’t be discharged even in a bankruptcy situation. Talk to your lender about the options available for you, this can be crucial to maintaining a favorable credit history.
If you have any questions about refinancing your student loans or improving your credit score, please contact your Financial Planner here at The Center, we’re always happy to help!
Josh Bitel is a Client Service Associate at Center for Financial Planning, Inc.®