How Does Paying Off Student Loans Affect Credit Score
Student loans can have a negative impact on your credit score, but it depends on how you manage them.
Student loans are considered to be installment debt, which means that you’re required to make monthly payments over time until the debt is repaid. They are also categorized as “non-mortgage,” meaning they don’t qualify as collateral for a mortgage loan. This makes student loans more difficult to pay off than other types of debt like credit cards and car loans because they don’t have any collateral value.
You can see why this might cause some problems with your credit score—you’re unable to pay off the loan in a lump sum or refinance it like other types of debt would allow you to do. If you don’t keep up with your monthly payments, then your lender will report it as missed payments and this can hurt your credit score over time as well.
How Does Paying Off Student Loans Affect Credit Score
Yes, having a student loan will affect your credit score.
Your student loan amount and payment history will go on your credit report. Making payments on time can help you maintain a positive credit score. In contrast, failure to make payments will hurt your score. Establishing a good credit history and credit score now can help you get credit at lower interest rates in the future. If you think you may not be able to make your payments, contact your servicer to find out more options.
Student loans affect your credit in much the same way other loans do — pay as agreed and it’s good for your credit; pay late, and it could hurt it. Student loans, though, may give you extra time to pay before you are reported late.
Student loans are generally installment loans — you pay a specified amount for a certain time period. The lender reports this to credit bureaus, and you begin to establish a track record.
If you pay on time, every time, you’ll begin to establish a solid record of managing credit.
Here’s what you need to know about how student loans can affect your credit score.
If you pay late or skip a payment
Forgetfulness happens, and a brief bout won’t impact your credit. Your score will start to drop only after your lender reports your late payment to one or — more likely — all of the three major credit bureaus.
How long before it’s reported depends on the type of loan you have:
- Federal student loans: Servicers wait at least 90 days to report late payments.
- Private student loans: Lenders can report them after 30 days.
However, lenders can charge late fees as soon as you miss a payment.
If your lender does report your late payment, also known as a delinquency, it will stay on your credit report for seven years.
The more overdue your payment, the worse the damage to your credit. For instance, your federal student loan will go into default if you don’t make a payment for 270 days. That will hurt your credit even more than a 30- or 90-day delinquency.
If you cannot pay your student loans
Sometimes money gets tight. In those situations, ask your lender about lowering or pausing your monthly student loan payments. You might be able to:
- Sign up for an income-driven repayment plan if you have federal loans.
- Apply for a modified payment plan if you have private loans and your lender offers this option.
- Enroll in deferment or forbearance to temporarily pause your monthly payments.
Changing the terms of your loan does not hurt your credit. As long as you handle payments as agreed — even if that means paying $0 per month — your credit score shouldn’t suffer.
Does Student Loans Affect Buying A House
With current mortgage rates at historic lows, you may want to consider buying a home soon if you are ready to take that step. But if you have student loan debt, you may be wondering whether it could affect your ability to get a great deal on a mortgage, or even to buy a home at all. While it is true that too much existing debt is likely to affect your interest rate and even whether you qualify for a mortgage, in most cases you can – and should – still consider buying a home if you are ready.
Student loans don’t affect your ability to get a mortgage any differently than other types of debt you may have, including auto loans and credit card debt. When you apply for a mortgage, your lender will assess all of your existing monthly payment obligations, including student loans, to determine whether you would be able to manage the additional monthly payment. Depending on your situation, the lender will decide whether you qualify for the new loan, and if so at what interest rate.[
For that reason, you should consider how both your monthly student loan payment and a hypothetical mortgage payment could affect your debt-to-income ratio and overall credit score before you apply for a mortgage. In other words, if you have any existing debt, you need to be careful that you will be able to manage all your monthly payment obligations with your current income.
This calculation varies a bit depending on the type of mortgage loan you choose.
Potential homebuyers can choose between a conventional mortgage from a private lender, like a bank or other financial institution, or an FHA loan, which is a mortgage backed and insured by the Federal Housing Administration for people with limited savings or lower credit scores. This backing enables the lender to offer you a better deal, which typically includes a lower minimum down payment and easier credit qualifying. Recent changes to the way lenders must calculate monthly student loan payments can make the FHA loan a more attractive option for those with student loan debt, particularly first-time homebuyers.
Your student loan debt affects whether you can buy a house, in both direct and indirect ways. Here’s how:
- Student loan payments make saving for a down payment more difficult and mortgage payments harder to handle once you’re a homeowner.
- Student loan debt may increase your debt-to-income ratio, affecting your ability to qualify for a mortgage or the rate you are able to get.
- Missing a student loan payment can lower your credit score, but consistently paying on time can bolster it.
Having student loans, though, doesn’t mean you’ll never be able to get a mortgage. Here’s what you should know as you explore your options.
Student loan payments hinder savings
Sending hundreds of dollars a month to your lender or servicer may feel like the most immediate, and most frustrating, way student loans affect your ability to buy a house.
But saving up 20% of the home’s value for a down payment, traditionally the ideal amount, isn’t always necessary. Look into first-time home buyer programs in your state, which can provide money for the down payment, or low-down-payment mortgage options.
Federal agencies like the Federal Housing Administration and the U.S. Department of Veterans Affairs also offer mortgages that require smaller down payments — or none at all, in the case of VA loans.
Student loans add to your debt-to-income ratio
When deciding whether to approve you for a mortgage, lenders look at how much debt you already have compared with your pretax income. That’s called your debt-to-income ratio, known as DTI, and it’s calculated based on monthly debt payments.
There are different types of debt-to-income ratios, and not all mortgage lenders calculate them the same way. But in general, car loans, student loans, minimum credit card payments and child support all factor in. The more debt you have — or the lower your income — the higher your DTI will be.
A DTI of 36% or less is ideal, but government-backed mortgages, like FHA loans, may approve you with a DTI of up to 50%.
Consider focusing on paying off student loans, or credit cards if they have higher interest rates, and don’t add to your debt before buying a home. You could aim to get rid of one student loan payment before you apply for a mortgage; paying off the loan with the highest interest rate will save you the most money over time.
Refinancing student loans to a lower monthly payment may also reduce your debt-to-income ratio. But it adds a line of credit to your credit report and may extend your repayment timeline. Make sure you refinance six months to a year before you apply for a mortgage. That lets positive payment history offset the credit score dip that may occur from shopping for a refinance loan.
best way to pay off student loans for credit score
The best way to pay off student loans is to pay more than the minimum each month. The more you pay toward your loans, the less interest you’ll owe — and the quicker the balance will disappear.
Use a student loan payoff calculator to see how fast you could get rid of your loans and how much money in interest you’d save. Here are seven strategies to help you pay off student loans even faster.
- Make extra payments the right way
There’s never any penalty for paying student loans early or paying more than the minimum. But there is a caveat with prepayment: Student loan servicers, which collect your bill, may apply the extra amount to the next month’s payment.
That advances your due date, but it won’t help you pay off student loans faster. Instead, instruct your servicer — either online, by phone or by mail — to apply overpayments to your current balance, and to keep next month’s due date as planned.
You can make an additional payment at any point in the month, or you can make a lump-sum student loan payment on the due date. Either can save you a lot of money.
For example, let’s say you owe $10,000 with a 4.5% interest rate. By paying an extra $100 every month, you’d be debt-free more than five years ahead of schedule, if you were on a 10-year repayment plan.
- Refinance if you have good credit and a steady job
Refinancing student loans can help you pay off student loans fast without making extra payments.
Refinancing replaces multiple student loans with a single private loan, ideally at a lower interest rate. To speed up repayment, choose a new loan term that’s less than what’s left on your current loans.
Opting for a shorter term may increase your monthly payment. But it will help you pay the debt faster and save money on interest.
For example, refinancing $50,000 from 8.5% interest to 4.5% could let you pay off your student loan debt nearly two years faster. It would also save you about $13,000 in interest, even with payments that stay about the same.
You’re a good candidate for refinancing if you have a credit score in at least the high 600s, a solid income and a debt-to-income ratio below 50%. You shouldn’t refinance federal student loans if you want or need programs like income-driven repayment and Public Service Loan Forgiveness.
- Enroll in autopay
If you don’t want to refinance your loans, signing up for autopay is another potential way to lower your student loan’s interest rate.
Federal student loan servicers offer a quarter-point interest rate discount if you let them automatically deduct payments from your bank account. Many private lenders offer an auto-pay deduction as well.
The savings from this discount will likely be minimal — dropping a $10,000 loan’s interest rate from 4.5% to 4.25% would save you about $144 overall, based on a 10-year repayment plan. But that’s still extra money to help pay off student loans fast.
- Make biweekly payments
This simple strategy is a way to trick yourself into paying extra on debt: Pay half of your payment every two weeks instead of making one full payment monthly.
You’ll end up making an extra payment each year, shaving time off your repayment schedule and dollars off your interest costs. Use a biweekly student loan payment calculator to see how much time and money you can save.
- Pay off capitalized interest
Unless your loans are subsidized by the federal government, interest will accrue while you’re in school, your grace period and periods of deferment and forbearance. That interest capitalizes when repayment begins, which means your balance grows, and you’ll pay interest on a larger amount.
Consider making monthly interest payments while it’s accruing to avoid capitalization. Or make a lump-sum interest payment before your grace period or postponement ends. That won’t immediately speed up the payoff process, but it will mean a smaller balance to get rid of.
- Stick to the standard repayment plan
The government automatically puts federal student loans on a 10-year repayment timeline, unless you choose differently. If you can’t make big extra payments, the fastest way to pay off federal loans is to stay on that standard repayment plan.
Federal loans offer income-driven repayment plans, which can extend the payoff timeline to 20 or 25 years. You can also consolidate student loans, which stretches repayment to a maximum of 30 years, depending on your balance.
If you don’t truly need these options and can afford to stick with the standard plan, it will mean a quicker road to being debt-free.
- Use ‘found’ money
If you get a raise, a student loan refinance bonus or another financial windfall, allocate at least a portion of it to your loans. Consider using this breakdown: 50% of the extra income can go toward debt, 30% to savings and 20% to fun, discretionary spending.
Some companies pay off student loans as an employee benefit. Find out if your company offers an employer student loan repayment program, and be sure to enroll.
You can also start a side hustle to pay off student loans fast. Sell items like clothing, unused gift cards or photos; rent out your spare room, parking spot or car; or use your skills to freelance or consult on the side.v
Consider setting up rules for yourself, like putting any $5 or $10 bills you receive toward your loans. Some money-saving apps, like Digit and Qapital, will help you set savings goals and rules as well.