Do Student Loans Affect Your Credit Score? Yes, Here's How

Picture this: You’ve been actively making your student loan payments every month, only to find your credit score bouncing up and down like a yo-yo. It’s enough to make anyone feel frustrated and discouraged. But student loans can be a wild card with credit scores.

You’re juggling not just one but multiple balls in the air. Unlike car loans or mortgages, which typically appear as a single installment loan on your credit report, student loans often appear as several loans, each with its own payment history.

This means that if you’re doing great with making on-time payments, your credit score could soar! But on the flip side, if you stumble and fall behind, the late payments can cause your score to take a serious nosedive.

And here’s the kicker: If you default, it’s not just one default status that gets reported to the credit bureaus. It’s a whole bunch of them, all at once.

This will damage your creditworthiness and jeopardize your employment prospects, housing options, access to personal loans, refinancing options, etc.

Here’s what you need to know about how student debt can affect your credit score.

Student loans affect your credit score in three ways:

• Adding to your payment history. This makes up the lion’s share of your score, 35%, and relies on your making on-time payments. Late or missed payments on your student loan will negatively affect your score.

• Raising the length of credit history. This accounts for 15% of your score. The longer you have your student loans, the older the average age of all your credit cards, personal loans, and the like. Lenders don’t like borrowers with a bunch of new credit accounts. They want to see that you keep and hold onto your accounts.

• Diversifying your credit mix. Student loans add variety to your credit mix and show your ability to manage different types of debt.

Because your payment history has an outsized impact on your credit score, you want to keep your account in good standing by any means necessary. That means switching to an income-driven repayment plan to get a payment you can afford or pausing your bill temporarily with a deferment or forbearance to avoid missed payments.

Yes, you can have a good credit score with high student loan balances — so long as you stay on top of your payments to your loan servicer. The notion that high student loan debt invariably results in a dismal credit score is a myth. Recent data reveals that borrowers can achieve a strong credit score even with substantial student loan debt. The key: make your payments on time.

Installment loans such as student loans have a comparatively lower impact on credit scores than revolving credit. Indeed, FICO data shows that many borrowers with over $50,000 in student loan debt have a credit score above 700.

Note: FICO’s newest scoring model won’t ding you for having student loans.

To be fair, for the longest time, large student loan debt stood in the way of homebuyers trying to secure a mortgage. But that blockage has been removed in recent years, thanks in part to the efforts of HUD Secretary Marcia Fudge, who promptly eliminated a rule that had long plagued the FHA home loan program.

The new FHA student loan guidelines removed the cumbersome calculation that forced lenders to use 1% of a borrower’s student debt for their debt-to-income ratio, no matter their repayment plan. Now banks, credit unions, and other lenders can use the borrowers’ actual monthly loan payments, clearing the path for those with high loan balances to buy a home while they wait on student loan forgiveness.

As with any other type of credit, paying your student loans by the due date has the biggest impact on your credit score. You’ll be doomed without it.

But keep in mind that only the student loans you borrowed or cosigned will affect your credit score. So if you borrowed a Parent PLUS Loan for your child, the loan would be added to your credit file — not your child’s. And the loan would only affect your credit score.

The only way to change that is to transfer the Parent PLUS Loan to your child.

Yes, student loans can affect your credit score before you graduate. While no payments are due because your loans remain in deferment while you’re still in school, there are three ways that student loans impact your score.

• New loans. You’ll get additional federal student aid or private loans each semester. Those loans will add new lines of credit to your report, which will decrease the average age of your accounts, potentially lowering your score.

• Private loans and hard inquiries. Private lenders check your credit report before approving new loans. These hard inquiries may reduce your credit score by a few points.

• Deferment status. Although the FICO credit scoring model doesn’t ding your score because your loans are in deferment, the deferred status can lower the credit scores generated by free credit tracking tools like CreditKarma, which rely on the VantageScore formulas.

That’s the bad news. The good news is that the additional loans can improve your score over time if you make your payments by the due date.

Your credit score and history can stand in the way of borrowing new loans if you’re returning to school or helping pay for your child’s education.

• Federal student loans. You don’t need a good credit score to get your loan application approved. But if you’re borrowing Parent PLUS Loans or Direct PLUS Loans for graduate school, the Education Department will require a hard credit check to look for an “adverse credit history” — i.e., recent past due payments, accounts with debt collectors, bankruptcy filing, and so on.

• For private student loans. Private lenders will perform a credit check to determine whether you meet their eligibility requirements to borrow a loan. The higher your credit score, the more likely your lender will approve your loan application without a cosigner, and you’ll get a lower interest rate. But if you’re an undergraduate student just starting to build credit or are recovering from a financial hiccup, you’ll need a cosigner to borrow private student loans.

After you leave school, you might want to refinance to get a lower interest rate. Shopping around with different lenders is smart, but to stop student loan refinancing from hurting your credit score, use an online marketplace like Credible. That way, you can get rate estimates from different lenders simultaneously without making a hard inquiry.

Defaulting on student loans affects your credit score by adding late payments and a default status to your credit history for every loan you’ve defaulted on.

Payment history is the most significant factor affecting your credit score, so missing just one monthly payment on your student loans can sting. If you miss enough payments, your loans will default, causing your FICO score to plummet by 50 to 90 points, according to a report from the Urban Institute.

Your score drops after your servicer reports the missed payment to the credit bureaus. How quickly that happens depends on the type of loan you have.

Federal student loans wait 90 days

Federal loans report late payments to credit bureaus after three consecutive missed monthly payments. The loan servicer will continue reporting the delinquency for six more months, totaling nine months, until the loan defaults.

Once that happens, your servicer will report the default status to the bureaus and move the defaulted loans to the company that handles collections for the U.S. Department of Education, Default Resolution Group, and report that your student loan account has been closed due to transfer. The DRG will take over credit reporting duties until you get out of default.

Private loans may report late payments immediately

In stark contrast to the federal government’s credit reporting policy, private loan holders report delinquent payments to Equifax, Experian, and TransUnion after a single payment is missed.

Many private lenders will report that the loans defaulted or were charged off private loans after 180 days or six months of missed payments.

Regardless of the type of student loan you default on, federal or private, the default status will stay on your credit report for seven years or until you return the student loans to good standing.

Follow these two steps to rebuild your credit after defaulting on student loans.

Step 1: Fix your defaulted loans

Normally, borrowers have two options to return their account to good standing:

• Loan consolidation, which pays off the defaulted student loans and gives you a new loan with a fixed interest rate

• Loan rehabilitation, which forces you to make nine monthly payments to a collection agency

But during the pandemic, the Biden administration introduced a third option: Fresh Start. Under this program, federal student loan borrowers can avoid the consequences of default — wage garnishment, tax refund offset, Social Security garnishment, and so on — and bring their loans current by agreeing to a long-term payment plan, typically based on their discretionary income.

The Fresh Start Program has an added benefit: the negative mark of default on borrowers’ credit reports will be removed as part of Fresh Start, according to the Education Department.

Private student loan creditors rarely have programs to restore defaulted loans. Your only options may be to pay the balance in full, refinance defaulted student loans with a new lender, or negotiate a student loan payoff.

Step 2: Work on your other debts

You can do some things to help rebuild your credit while working on getting out of default. Some good practices include:

• Paying your other bills, credit cards, mortgage, etc., on time. Payment history has the most influence on your FICO score.

• Keeping your credit card balances low or paying them off every month is possible. Credit utilization, or how much credit you use, is the second most important factor in your credit score.

• Adding to your credit mix. The right combination of credit can raise your score. It shows lenders you can responsibly pay back other types of debts, including secured credit cards, auto loans, personal loans, etc.

Student loans can have an outsized impact on your credit score. The key is ensuring you always have an affordable monthly payment to avoid delinquency and default. Let’s talk if you want help exploring consolidation or refinancing student loans to lower your monthly payment. Book a call with me to learn how I can help.