Understand the Impact of Student Loans on Credit Scores

Making on-time payments can positively affect your FICO score.

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excellent credit score.jpg
An excellent credit score.

Given the continued rise in student debt (including six-figure student loan debt), a question the Student Loan Ranger hears a lot is, "Will my student debt have a negative impact on my credit score?"

The answer is no. In fact, it can even positively impact your score if you handle it responsibly.

It's helpful, as a starting point, to understand how FICO scores work. Back in 1956, Fair Isaac and Company (hence, FICO) developed an algorithm to determine how risky it is to lend a person money. While the exact nature of the algorithm is proprietary, it is based on five categories in roughly these proportions: payment history (35 percent), amounts owed (30 percent), length of credit history (15 percent), types of credit in use (10 percent) and new credit (10 percent). 

The three major credit bureaus (Experian, TransUnion, and Equifax) use software developed by Fair Isaac and Company and information they keep on file about you to develop your FICO scores. Your scores will change (for better or for worse) as your financial history changes. The scores range from 300 to 850; higher scores are better.

[Find out what it takes to have a perfect credit score.]

When you apply for credit, most lenders ask the credit bureaus for your FICO scores as part of assessing the risk of lending to you and therefore to determine how much and on what terms they will lend to you. Improving your FICO scores can help you get better terms, including better interest rates, from lenders. 

With this in mind, let's look at an August post from the FICO Banking Analytics Blog, "Is Growing Student Loan Debt Impacting FICO® Scores?," which addressed the question of the impact of student loans on FICO scores. The post concludes that, despite a continued rise in student loan debt that outpaces the growth of other types of debt, large amounts of student debt do not result in lowered FICO scores.

In fact, borrowers with more than $50,000 in student loan debt tended to have higher FICO scores than average consumers in the 500 to 749 FICO score range. Although their scores tended to be lower in the bottom (300 to 499) and higher (750 to 850) FICO score range, approximately 7 percent of consumers with at least $50,000 in student loan debt have FICO scores in the 800s. The blog also notes that student debt is considered like any other installment credit and that deferring a student loan will not necessarily have a negative impact.

[Find out how to avoid student loan default.]

Once you understand the basic algorithm behind FICO scores, you can see how responsibly managing your student loans can potentially have a positive impact on your FICO scores. It can be a positive, for example, to have a longer credit history and add a different type of credit to your financial history.

What has the biggest impact, however, is making your payments on time and building up an excellent payment history. Remember, that accounts for roughly 35 percent of your FICO score.

In order to do that, the Student Loan Ranger recommends relying on federal loans as much as possible to finance your education and taking advantage of protective provisions like income-driven repayment plans, including President Obama's new Pay As You Earn plan, as well as deferment and forbearance, if you need them.

[Explore other ways to boost your credit score.]

There are a few other things you should be aware of regarding your FICO scores and student loans. As FinAid.org notes, although federal Stafford and Perkins loans are available entirely without regard to credit history, you cannot have an adverse credit history—including being more than 90 days late on any debt—and be eligible for a PLUS loan. Most private lenders will rely in part on FICO scores to determine your eligibility for student loans and the interest rate you will receive.

Shopping for student loans may negatively impact your credit score, but as long as you do it in a brief time period, the impact should be minimal. The National Consumer Law Center also has helpful information on how going into default or discharging your loan in bankruptcy can impact on your credit score.

The Student Loan Ranger advises getting a free copy of your credit report and correcting any inaccurate information. This is the information provided by the consumer reporting company to lenders, so it can have a real impact on your creditworthiness. If you have further questions about how to manage your student debt—and thereby ensure your continued creditworthiness— you can visit the Student Loan Ranger's website and utilize comprehensive resources like our free webinars and our new eBook.

Isaac Bowers is a senior program manager in the Communications and Outreach unit, responsible for Equal Justice Works' educational debt relief initiatives. An expert on educational debt relief, Bowers conducts monthly webinars for a wide range of audiences; advises employers, law schools, and professional organizations; and works with Congress and the Department of Education on federal legislation and regulations. Prior to joining Equal Justice Works, he was a fellow at Shute, Mihaly & Weinberger LLP in San Francisco. He received his J.D. from New York University School of Law.