For many borrowers, student loans are the first opportunity they have to start building credit. This helps shape the way lenders will see them in the future. Therefore it is imperative to handle student loan repayment responsibly. As a result, graduates’ credit history and credit score will benefit later in life in the debt management process. Here is how student loans and the various repayment options affect credit scores.
How Student Loans Affect Credit Scores?
Deferment will not hurt a recent graduate’s credit score.
The decision to defer repayment or not is the first major decision grads need to make as their grace period ends. It is perfectly common for grads to struggle a little financially right out of college. This is the time they adjust to paying rent, utilities, and other expenses on their initial salary right out of school. In any case, we do not recommend delaying your repayment process. This is because borrowers will still incur interest charges on their loans. However, sometimes you will not have the funds to make the payment. In those instances, deferring repayment is always better than making late payments, missing payments, or defaulting on loans in the student loan debt relief process.
Pick the right repayment plan to build a solid credit history.
Repayment amounts and terms are different from person to person. Borrowers can choose to repay using either of the following:
- Fixed amount
- A gradually increasing payment
- An income-based repayment
In addition, they can also get smaller payments by extending the length of repayment from 10 years to 15 or more. Extending repayment or reducing payment amounts by choosing graduated or income-based plans will NOT negatively impact a credit score.
However, grads should choose whichever repayment option they can afford. And make sure that allows them to repay the loan in the shortest possible time. This way they can reduce the interest they will pay over time. As long as payments are made on time each month, your credit score will benefit.
Student loans are considered “good credit.”
This is because they are reported as installment loans rather than revolving credit, like credit cards. This means that having an outstanding balance will not adversely affect lenders’ willingness to offer credit. As long as payments are being made in full and on time, graduates are able to acquire mortgage loans or other types of credit.
Student loan forgiveness will not negatively impact a credit score.
Depending on the career path of some graduates, they may qualify for student loan forgiveness at the end of a set term. In this instance, they discharge the remaining balance of the loan. And then no further payments are made. The important thing is to make payments on time and the borrower’s account is in good standing. If the requirements are fulfilled, student loan forgiveness will not harm the credit history.
A credit score may initially drop upon repayment or discharge.
If borrowers do not have other installment credit, like a mortgage, then paying off student loan debt in full can cause a slight drop in score. This is because it reduces the variety of credit on one’s “credit resume.”
Delinquency and defaulting on student loans will negatively impact a credit score.
Student loans are a great way to positively build credit right out of college. However, missing payments or allowing loans to default is the easiest way to ruin credit quickly. As soon as a borrower starts making payments again, the score is likely to bounce back quickly. Defaulting on a loan will severely damage a credit score for 7 years or more. As a result, it can be incredibly difficult to acquire other forms of credit like a mortgage, personal loan, or even a credit card.
The bottom line is that grads should decide on a repayment plan they can afford. If they aren’t able to afford to make any payment amount, deferment is acceptable. However, interest will accrue and it will take longer for debt relief.
Taking too long to pay off a student loan can look bad to future creditors. However, as long as the payments were all made on time, then the impact will be minimal. Forgiveness or discharge are also options but should be carefully considered because there are credit and tax implications that go along with those methods of dealing with student debt.
If you’re struggling to pay off debt, ACCC can help. Schedule a free credit counseling session with us today.