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Before taking out student loans to pay for college, student loan borrowers are advised to only take out loans as needed. Depending on your financial circumstances, you may need significant loans and you're likely wondering if paying a student loan builds credit.
Students today often have no choice but to borrow money to keep up with the rising cost of college, reaching a record high of $1.75 trillion in total student loan debt as of 2022. 92% of all student debt comes from federal student loans while the remaining 8% comes from private loans.
While student loans have led to lasting college debt, there is a way to turn the situation in your favor. It's true: your student loans build credit. They actually give students an opportunity to show the major credit bureaus, Experian®, Equifax®, and TransUnion®, that they are responsible credit users.
Credit scores are calculated based on many factors that determine your creditworthiness. Here are a few ways that paying student loans can affect your credit score:
- Diversify Your Credit Mix — Credit scoring models, like VantageScore® and FICO®, look at how many different types of credit accounts you hold. Do you only use student credit cards, or do you have a mix of credit accounts? Taking on student loans adds diversity to your credit mix, showing you are capable of managing many different financial demands and reducing your overall risk as a borrower. However, credit mix only makes up 10% of your score, so it's not worth taking on student loans for this small score factor alone.
- Long-term Payments — The quality of your payment history makes up 35% of your credit score. View your student loan as an installment loan. You'll make monthly payments over a fixed period of time that will show up on your credit report. As long as your monthly student loan payments are made on time and in full, paying the loan in installments is enough to have a positive payment history and improve your credit scores.
- Boost Your Average Account Age — The length of your credit history is worth 15% of your FICO score. Having a longer credit history is preferred. If you as a student haven't begun building a credit history yet, staying on top of your student loan payments is a good place to start. With most repayment plans ranging between 10 to 30 years, making regular payments in full will show in your credit history, which in turn is very influential in building a good credit score.
All of these credit pros rely on how you handle your personal finance with consistency and timeliness. The goal is to show that you can manage and pay back long-term debt. For more tips on how to handle your finances, read this guide on how to save money in college.
Even though student loans can help you build credit, it's still a good idea to limit your loan total. Scholarships can help you do so as they're a form of financial aid that doesn't need to be repaid. Bold.org is a scholarship platform that offers hundreds of exclusive opportunities. You can sign up for free to begin applying for scholarships!
Is paying off student loans early worth it?
There is no penalty on your credit report for paying off student loans earlier than the agreed-upon repayment period. Student loans will only continue to accrue interest, especially ones with high variable interest rates. The sooner you pay off your student loan debt, the more you save money on interest payments and can begin to invest in your financial goals.
Taking the necessary steps towards paying off student loans early means paying larger or additional amounts, so your monthly payment amount may be higher. On-time payments on your credit history are the biggest influence on your credit score. Make sure you are financially able to keep up with paying a higher monthly payment.
There are instances where paying student loans off early may not be the best plan. If you have a large, outstanding balance on other credit, such as immense credit card debt, then paying off student loans early may not be the right move to take right now. Paying off the outstanding balance should take first priority to avoid credit card companies raising your annual percentage rates (APRs). Some people choose to make student loan payments through a secured credit card, which has its own consequences like increasing credit utilization.
You may even lose out on opportunities for student loan forgiveness that you would be eligible for after a certain amount of time in your qualified career. In this case, it wouldn't be worth it to pay your loans in full early on. It would be better to continue making on-time payments until your education debt is forgiven.
Ultimately, it is worth paying off your federal student loans or private student loans when there is a high interest rate involved. However, be sure that your circumstances allow it. Coordinate with your student loan servicer about the steps you should take toward paying off your debt early.
Will paying off a student loan in default raise my credit score?
If you miss multiple payments, your student loan is at risk of going into default— which will remain as part of your credit report for up seven years. This status won't look so good on your payment history, and default student loans hurt your credit score.
If this happens, you will be blocked from applying for forbearance or deferral and will no longer be eligible for student loan forgiveness on federal loans. Student loans in default will make it harder to get credit approval for future loans and new lines of credit, and variable interest rates will increase as your credit risk increases.
Federal loans will usually move into default 270 days after the first missed payment. Other types of loans, such as private student loans, can go into default much sooner. Typically, private loans move into default in 120 days after three late payments, but private lenders can report to the three major credit bureaus about your default after 90 days.
The stage between the first missed payment and moving into default is referred to as delinquency— think of it as a warning to properly monitor your loans before it reaches the more severe default stage.
Every student loan payment made in default is actually hurting your credit score. Remember that student loans build credit only if you are responsibly making your student loan payments. It's best to stick to a habit of timely payments and to pay in full.
What happens when a student loan is paid off?
Your final student loan payment is a huge milestone! You've overcome student loan debt and have reached the next stage of your financial journey. As you near the end of your repayment period, there are a few things to be prepared for.
Once a student loan is paid off, your credit score may temporarily drop. Now that the loan term is over, the student loan will be removed from your credit mix. If your credit portfolio doesn't have a mix of both revolving credit and installment loans, this dip in credit score may occur. But don't panic— the effects of successfully paying off a student loan in full on credit scores can differ for everyone. Plus, these changes will be temporary and can be just as easily reversed within the next few months.
In contrast, you'll notice your debt-to-income ratio (DTI) will drop too— and that's a good thing to see. DTI compares your monthly gross income to how much you owe each month in credit, which is what most creditors look at before lending money out to qualified borrowers to ensure they can afford monthly payments on new credit. The lower your DTI, the better.
Having paid back your federal student loans or private student loans in a timely manner during the duration of the loan term will prove to be beneficial as you continue to take on new lines of credit. Now that your credit report reflects your creditworthiness, you may be qualified for lower APRs and interest rates from now on. A lower interest rate on new credit is money being saved. Credit approval will be easier to get when applying for a personal loan.
Many of your financial goals that you couldn't focus on before will also become much more attainable. Consider using the amount that would have gone towards a monthly payment to start reinvesting. Put the amount into a savings account for an emergency fund. Invest it in a Roth IRA account or contribute to your 401(k) to get a boost in retirement funds. You could even start paying off interest and making payments on a mortgage and other loans in your credit portfolio, such as credit card payments or payments on an auto loan.
Frequently asked questions about student loans and credit
What's the highest credit score you can receive?
A credit score is a three-digit number that measures your risk and reliability in paying back debt based on your credit report. Credit scores can fall anywhere between 300 to 850, with 850 being the highest credit score you can receive.
The ranges for what is considered "good credit" and what is considered "bad credit" tend to vary depending on which credit scoring model you use. Most credit rating companies follow a general consensus:
- 300-579: Poor credit
- 580-669: Fair credit
- 670-739: Good credit
- 740-799: Very good credit
- 800-850: Excellent credit
A credit score is a fundamental factor that affects your financial life. Having poor credit will increase the range of variable interest rates you'll have to pay for future lines of credit. It makes it harder to get a lease on an apartment or house or get approval for new loans.
Student loans affect your credit score. Depending on how you handle monthly payments, student loans can either help you receive a positive credit score or hurt your credit score. On-time payments tracked in your financial history will improve your score, while late payments reported to the credit bureaus will drop your score.
Personal finance can be a tough thing to navigate. It's common for many borrowers to steer off from their timely payments on occasion. Speak to your lender or loan servicer about helpful options such as refinancing student loans, requesting a deferment, or taking a credit builder loan. You can also request to check your credit report annually for free from each of the three credit reporting agencies: Equifax, Experian, and TransUnion.
Can I pay my student loan in full?
If you are financially able to do so, you can pay off your student loan in full at any time. Lenders refer to paying off your student loan early as “prepayment in full.” Generally, there are no penalties on your credit score for doing so.
Rather than continuously making federal student loan payments or private student loan payments, you can save money on what you would have paid in accrued interest. However, be sure that paying off loans early is in the best interest of your current financial situation.
Check with your student loan service provider to get a "payoff quote" of how much you currently owe in order to pay off your federal student loans or private student loans in full.
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