How Do Student Loans Affect Your Credit Score?
Loan accounts are a big part of your credit score, but student loans are a somewhat special case. For example, while you are in school, you don't have to make any payments. A question on many students' minds is: How does this all affect your credit?
Here is a quick overview of how student loans influence your credit score during and after college, and what could happen if you're having trouble paying.
While you're in school, or not paying yet
The short answer is that before you enter your repayment period, your Federal student loans do not affect your credit score. There is no payment history to report, so there is nothing positively or negatively affecting your score. However, the full answer is a little more complicated.
While your Federal loans don't affect your credit score, they do still show up on your credit report. As a result, lenders can take them into consideration when deciding whether or not to lend you money.
For example, if you have $50,000 student loans and want to buy a car, a lender can take that debt and its anticipated payment into account when determining if you'll be able to afford to pay back the car loan.
Once you start repaying
After your loans enter repayment, they are included in the credit scoring formula similarly to any other loan account. However, with today's income-based repayment plans, it's not quite that simple.
For example, if your monthly loan payment is less than the amount of interest that accrues on your account, your loan balance can actually increase over time.
A big part of your FICO credit score (30%) comes from "amounts owed". And a part of that is the balance on your loan accounts relative to their original balance. Creditors want to see that you can handle your debts and are doing a good job of paying them off. So, if your student loan payments are causing your balance to decrease each month, it should be a positive factor in your credit score.
On the other hand, if your payments are less than the interest that accumulates, you'll still have the positive factor or a great payment history (which makes up 35% of your score), but the amounts you owe on the loans will not be a positive factor.
In order to maximize the impact of your student loans on your credit score, you should make an effort to pay more each month than the interest that builds on your account, even if you aren't required to do so.
If you are unsure how much that is, a simple calculation is to multiply your loan balance by your annual interest rate, then divide by 12 to find how much interest accumulates in a month.
For example, if you have $30,000 in loans at 6.8% interest, $30,000 times .068 divided by 12 equals $170 in interest per month. In order to make your balance go down, you'll need to pay more than this amount.
What if you're struggling?
Student loans are unique in that there are several options available to help you avoid late payments and defaults. Depending on your situation, you may be able to qualify for a deferment or a forbearance, which allows you to stop making payments on your loan without the adverse credit effects of missed payments.
And if you do miss a payment, by maintaining a solid payment history for a few years, lenders have been known to (but are not required to) stop reporting the late payment as a sign of goodwill.
In a nutshell, student loans are rather unique not only in the way they are reported, but in regards to the amount of control you have over how you repay them. With some solid planning, your student loans can be an asset to your credit, and even if you don't make huge payments, they don't necessarily have to be a negative factor.
1 great stock to buy for 2015 and beyond
2015 is shaping up to be another great year for stocks. But if you want to make sure that 2015 is your best investing year ever, you need to know where to start. That's why The Motley Fool's chief investment officer just published a brand-new research report that reveals his top stock for the year ahead. To get the full story on this year's stock -- completely free -- simply click here .
The article How Do Student Loans Affect Your Credit Score? originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.