Student loans are a significant component of the United States economy, with nearly 43 million Americans carrying student loan debt.
The total outstanding student loan debt is over $1.7 trillion, making student loans the second-largest consumer debt category in the country after mortgages.
With such a large number of people holding student loans, it is essential to understand how student loans are factored into credit scores.
What is a credit score?
Before we dive into the details of how student loans are factored into credit scores, let’s first understand what a credit score is. A credit score is a three-digit number that represents a person’s creditworthiness.
Lenders, credit card companies, and other financial institutions use credit scores to determine a person’s capacity to repay debt.
The most commonly used credit score in the United States is the FICO score, which ranges from 300 to 850. Higher credit scores indicate a lower credit risk, while lower credit scores indicate a higher credit risk.
How are credit scores calculated?
Credit scores are calculated based on several factors, including payment history, credit utilization, length of credit history, credit mix, and new credit. Payment history is the most critical factor, accounting for 35% of a person’s credit score.
If a person has a history of missed or late payments, their credit score is likely to be lower. On the other hand, if a person consistently makes timely payments, their credit score is expected to be higher.
Credit utilization is another significant factor that affects credit scores. Credit utilization refers to the amount of credit a person uses compared to their credit limit. High credit utilization can indicate a higher credit risk, resulting in a lower credit score.
How are student loans factored into credit scores?
Student loans are treated no differently than any other loan regarding credit reporting. When a person takes out a student loan, the loan information is reported to the three major credit bureaus – Experian, Equifax, and TransUnion.
The loan information includes the loan amount, the date the loan was opened, the current balance, and the payment history. If a person makes timely payments on their student loans, it can help improve their credit score.
On the other hand, if a person misses payments or falls behind on their student loan payments, it can negatively impact their credit score. Late or missed payments can stay on a person’s credit report for up to seven years, making it harder to get approved for loans or credit cards in the future.
How can student loan borrowers improve their credit scores?
If you have student loans, there are several steps you can take to improve your credit score. Here are some tips:
- Make timely payments – One of the easiest ways to improve your credit score is by making timely payments on your student loans. If you consistently make on-time payments, it can positively impact your credit score.
- Pay more than the minimum – If you can afford it, pay more than the minimum amount due each month. This can help you pay off your student loans faster and reduce the amount of interest you pay over time.
- Keep credit utilization low – As mentioned earlier, credit utilization is a significant factor that affects credit scores. Try to keep your credit utilization below 30% of your credit limit.
- Monitor your credit report – Regularly check your credit report for errors or inaccuracies. If you notice any mistakes, dispute them with the credit bureau.
- Avoid opening new credit accounts – Opening several new ones quickly can negatively impact your credit score. Try to limit the number of new credit accounts you open.
In sum, credit scores do take into account student loans the same way they do other types of loans. Paying your student loans on time can help your credit while missing or being late can hurt it.
Student loan borrowers can better their credit and financial situation by following the advice given above.