Millions of Americans have student loan debt and with tuition prices climbing steadily, it’s likely that the borrowing trend will continue. Taking on loans can have some serious financial implications, particularly with regard to your credit. If you’re about to graduate or you’re already in student loan repayment mode, it’s important to be aware of the impact it can have on your creditworthiness.
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Student Loan Payments Will Show up on Your Credit Report
Your credit report is a detailed account of your debt obligations, balances and payment history. When you sign on the dotted line for a student loan, you can be sure that your loan servicer is going to report all of your relevant account information to each of the three major credit bureaus.
The information that’s included in your credit file is used to shape your credit score and your payment history is the most important factor. If you miss a payment on your loans, your lender will make a note of it on your file which can cause your score to drop.
If you haven’t had a chance to build credit through other avenues, like a credit card or home loan, the effect can be devastating. The problem becomes even worse if your account goes into default.
Student Debt Carries a Different Kind of Weight
Student loans are categorized as installment loan because you pay a set amount each month until the debt is wiped out. With a revolving line of credit, such as a credit card, your balance fluctuates as you charge new purchases or make payments. It doesn’t seem like a huge distinction, but it matters when it comes to how your credit score is calculated.
While it’s good to have a mix of different credit types showing up on your report, revolving lines tend to factor into your credit score calculation more heavily. Installment loans provide a less accurate way of predicting credit risk compared to a credit account that you’re using over and over again.
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Your Loans Can Have a Negative Impact on Your Credit Utilization
One of the things lenders consider when looking at an application for new credit is how much of your total credit limit you’re already using. This is known as your credit utilization ratio.
Normally, installment loans don’t have a big impact on this ratio. But when you’ve borrowed tens of thousands of dollars in student loans, it may cause lenders to raise an eyebrow if you don’t have any other open lines of credit to balance it out.
The other issue with taking out a substantial amount of loans is that it means you have quite a bit of money to pay out each month. If you’re trying to get a mortgage, lenders usually prefer that you limit your debt payments to under a third of your monthly income.
When your loan payments account for a big chunk of your pay, it can cut down on the amount of house you’re able to buy. If your payments are too high, you may not even be able to get approved.
Related Article: Can Student Loans Keep You From Getting a Mortgage?
Use Deferment and Forbearance Sparingly
If you’re in a position where you can’t come up with the cash to make your loan payments, your lender may allow you to defer them or request a forbearance. Putting your loans on the backburner temporarily won’t hurt your score directly, but lenders can still consider what you owe when making credit decisions. The other downside is that if you can’t defer the interest, you might end up with a bigger balance than you had when you started.
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