Can Student Loans Help My Credit Score?
What does Tesla’s new Model 3 have in common with a bachelor’s degree? The price tag on Elon Musk’s new car for the masses, $35,000, is almost exactly the same as the average amount of student loan debt recent graduates are saddled with.
It seems unfair to be penalized for taking out loans to challenge yourself academically and obtain skills that you need in order to start your career path. After all, to secure a better job for the future, you may have needed some financial help to get there. According to the CFPB, student loan debt is now the second-largest class of consumer debt behind mortgages, with more than 41 million Americans collectively owing more than $1.2 trillion in student loans.
So, is there a silver lining to all this debt? While the numbers are scary, student loans actually help you build your credit history and strengthen your credit score, especially for those recent graduates still avoiding credit cards. The key is to pay off the loans in a routine manner and demonstrate to lenders that you are responsible.
Since paying off student loans may initially be the first and only way to boost your credit score, here are some things to keep in mind as you explore your options further.
Federal vs. Private Loans
Federal loans are from the government and private loans are from banks, credit unions, or schools. So, what are the differences between the two? See the below chart for a quick recap.
Federal Loans Private Loans
Repayment begins… Post graduation While in school
Interest rates are… Fixed Variable
Subsidized interest… Yes, partially No
Is credit checked… Not typically May depend on credit score
Tax deductions… May be deductible Not deductible
Repayment assistance… Temporary postponements No forbearance or deferment
Prepayment penalty… None May exist
Loan forgiveness… Eligible in public service Not likely
Glancing through the above and assuming you can qualify, it seems that federal loans offer more flexibility and could be more helpful in managing your loan payments.
Every 30 Days, You Can Pay
Student loans are installment loans. This means that both the principal (how much you borrowed) and the interest (how much your lender is charging you on the amount you borrowed) will be repaid in fixed amounts over a predetermined amount of time.
Typically, you will have a fixed loan payment every 30 days. Depending on the amount you have borrowed, you may be making these payments for a few months or for many years.
But, by paying each monthly amount in full and on time, the credit bureaus will take note of your ability to stay on schedule and responsibly pay down your balances. And, this is how student loans can help you build your credit history. As installment loans, student loan debt also helps you diversify the types of credit accounts, even if you are already using credit cards, which are classified as revolving debt. Showing that you can pay off both responsibly is even better from a future lender’s perspective!
Defer Okay, Default NO WAY
If you’re struggling with paying your loans, you have two routes to follow. The first is deferment and the second is default.
People who choose deferment are not making enough money to currently pay their monthly loan balance. If you defer your student loans, you’re simply asking your lenders to give you more time – you are not asking them to remove the balances. Generally speaking, this shouldn’t hurt your credit score.
People who choose default have no way to make the money that they must pay back. This is the option of last resort – if you can avoid defaulting, you should. Once you have defaulted, you may be dealing with bad aftereffects such as a damaged credit history, ineligibility for future financial aid, potential unemployment, and the inability to secure other installment loans such as those for cars or homes. By defaulting on your loans, you may even be unable to ask your lenders for a deferment option in the future.
Student loans should be viewed like any other loan or line of credit. Making payments on time, will help your credit score and not making payments on time, will hurt your credit score. The key thing to remember is that your credit score will strongly benefit from timely and regular student loan payments.