Student loans have become a fact of life for almost everyone who pursues higher education. Though the struggle with student loans occurs on an individual basis, student debt’s overall impact on society is enormous; according to studies from the Federal Reserve Banks of New York and Cleveland, over 43 million Americans owe 1.26 trillion dollars in student loan debt.
The average four-year graduate now leaves school with around $30,000 in debt. This burden is nothing to sneeze at, especially when you consider that many graduates struggle to establish themselves in careers. However, student debt can have its benefits — at least in regards to credit. It’s not a one-way street, though, and borrowers must understand how student loans affect credit to manage them properly as assets.
Good Credit Loans
It can seem counter-intuitive that debt can benefit credit. Unlike credit card debt, however, student loans appear as “good credit” on a person’s credit history.
“Students loans are considered good credit because they’re reported as installment loans, rather than revolving credit,” says Katie Ross, education and development manager for American Consumer Credit Counseling. “Having an outstanding balance will not adversely affect lenders’ willingness to offer credit.”
Though many people build credit exclusively through credit cards, a diverse credit history looks much better to potential lenders. Not only that but creditors often see student loans as an investment in future earning potential.
Student loans’ capabilities to benefit credit mean nothing if the borrower fails to make on-time payments. As with any debt, missed payments have an immediate impact on your credit. Since credit bureaus treat student loans as installment plans, on-time payments get noted on a monthly basis. Future lenders will see this activity and take note, as it suggests an ability to manage finances and handle debt. Young adults, in particular, derive many benefits from on-time payments of student loans.
“Generally, traditional students have a thin or non-existent credit histories,” says Mark Kantrowitz of Cappex.com. “Once the student graduates, this short history causes the repayment of student loans to have a disproportionate impact on credit scores.”
To ensure that you receive disproportionate benefits — as opposed to drawbacks — you can take a few steps to help yourself make payments. Auto-debits enable your bank to pay loans automatically each month, while personal reminders and calendar alerts can help you stay on top of all your financial responsibilities.
Deferment and Delinquency
With all the uncertainties that confront college graduates, it’s understandable that many struggle to make loan payments. Borrowers should avoid letting loans become delinquent, however, as damage to credit scores can become extreme.
Since credit scores update frequently, missed payments can have an immediate impact. If a borrower misses payments for nine months, the loans go into default, with the entire balance due immediately. This will torpedo your credit, and the debt becomes inexpugnable even through bankruptcy.
Thankfully, alternatives exist to help borrowers manage student loans and avoid missed payments. If you have federal loans, you can apply for forbearance or deferments — which postpone payments — or income-based repayment plans. Loans in forbearance or deferment do not hurt credit scores, while income-based repayments scale downward based on how much you earn.
Debt Ratios and Payment Goals
One last concept must be explained to present fully how student loans affect credit: debt utilization ratios.
“The amount of debt owed can make up 30 percent of the average person’s credit score,” says Kevin Haney of SavvyOnCredit.com. “A high utilization ratio hurts scores, and ratings improve as the ratio declines.”
When student loans first become due, the utilization ratio — the amount of credit owed versus the amount available — is 100 percent. Financial experts recommend an overall debt utilization ratio of around 30 percent. Your utilization ratio falls as you pay down the loan’s balance, but the process takes time.
A graduate who wants to apply for a mortgage, or achieve other major financial goals, must devote serious attention to student debt. Student loans provide a blank canvas for the establishment of your credit history. As a student borrower, make sure you paint a picture you can live with.