College prices are rising, and more people have to take out loans to afford an education. Over 43 million people have student loan debt. Federal student loan debt currently tallies at $1.6 trillion and reflects a growing problem in the economics of higher education. Many people use these loans as a bridge to a college education, but they can also help you in other areas of your finances. Student loans play a role in your credit score and can help you qualify for a mortgage, auto loan, and other financial products.
The Importance of Building Your Credit Early
Building your credit score early opens numerous advantages. People with high credit scores get access to higher loan amounts and lower interest rates. Receiving more money for a mortgage will impact where you live. If you do not get enough money from the bank, you may get priced out of your preferred neighborhoods. Some homeowners settle for homes in dangerous areas because banks won’t provide higher loan amounts.
You can qualify for a loan with the minimum credit score requirement. However, an excellent credit score can save you thousands of dollars in your lifetime. Lower interest rates translate into lower monthly payments, making expenses feel more affordable. You would be shocked at who else looks at your credit score. Landlords look at your credit score as part of the application process, and utility companies will raise their prices if you have a low credit score.
An excellent credit score provides these advantages. A bad credit score not only results in missing out on benefits but also creates significant disadvantages. People with low credit have difficulty qualifying for conventional loans. Instead, they may have to resort to payday and title loans, two of the most predatory loans in the financial industry. These lenders don’t do credit checks, but borrowers can end up with triple-digit interest rates. Building your credit lets you tap into more advantages while exposing yourself to fewer disadvantages.
How Student Loans Affect Your Credit
Your credit score measures your ability to handle debt. It combines payment history, credit mix, and other details to create a financial profile for each consumer. For example, student loans are a type of debt, and how you pay off these loans reveals your debt management skills. Student loans can usually impact your credit score in the following ways.
Allows You to Make Positive Payments
Payment history is the largest credit category. It makes up 35% of your credit score. Positive payment history will add a few points to your score. Each time you make an on-time student loan payment, your credit will increase.
But Non-payment Can Harm Your Credit
Every loan works as a double-edged sword for your credit. Paying loans on time will improve your credit, but falling behind can harm your score. Most lenders give you a short grace period to make a loan payment before reporting late payments to the major credit bureaus. Late payments indicate difficulty with managing current financial obligations. As a result, your credit score will take a hit, and lenders will have less incentive to give you additional capital.
Increase Your Average Account Age
Credit history length is the third-largest credit scoring category, making up 15% of your credit score. Taking out a student loan increases your credit history length. As the credit age, it will continue to increase your credit score. Some students establish credit for the first time when they take out student loans. This jumpstart can give you a higher credit score than people who didn’t take out student loans and don’t have credit cards.
Diversify Your Credit Mix
Adding different types of debt to your credit demonstrates the ability to juggle multiple debts. Credit mix makes up 10% of your credit score. Student loans add more diversification to your debt, strengthening your credit mix in the process.
Does Paying Off Your Student Loans Build Your Credit?
Paying off any loan on time will improve your credit score. In addition, each student loan payment will improve your payment history, the most critical credit score category.
Some Tips to Build Your Credit Early
You don’t need student loans to build your credit early. You can use the following strategies to improve your credit even if you do not owe student debt.
Make Timely Payments
If you get a credit card or take out a loan, you’ll have the opportunity to build a strong payment history. Timely payments will improve your credit score and reduce debt’s impact on your life. Falling behind on payments will hurt your credit score and result in accumulating interest. Making timely payments will improve your financial health and credit score.
Become an Authorized User
Authorized users get to piggyback on someone else’s credit. A friend or family member can add you to their credit and impact your score. Every on-time payment helps authorized users. However, this privilege works as a double-edged sword. If you become an authorized user of someone who falls behind on payments, your credit score will also suffer.
You should only become an authorized user if you trust your family member or friend to keep up with the payments and improve their credit score. Adding someone as an authorized user doesn’t benefit or harm the primary account holder. Authorized users can receive a credit card with the primary account holder’s information and make transactions on their behalf. The primary account holder would be responsible for these payments, and this is common for parents who want their kids to have access to a credit card. However, the primary cardholder does not have to give their credit card to authorized users. Incurring this risk is entirely your choice.
Get a Secured Credit Card
A credit card is a valuable financial instrument for building your credit. Payments get reported to the major credit bureaus and improve your score. Unfortunately, most credit card issuers want to see a credit score before giving you a card, creating a Catch-22. Secured credit cards offer a path to a card that doesn’t require a credit score. The credit card applicant funds their credit card with cash in their bank account. This funding amount becomes the credit limit, and you have to replenish your credit card to continue using it.
Secured credit cards are more restrictive than traditional, unsecured credit cards. Many people use secured credit cards as their starter cards to build credit. These cardholders then switch to unsecured credit cards, which offer wider flexibility and reward systems.
Keep Your Credit Utilization Low
Your credit utilization is the second-largest credit score category, making up 30% of your total score. Credit utilization measures your current debt against your credit limit. If you owe $500 in credit card debt and have a $5,000 credit limit, you have a 10% credit utilization ratio. A credit utilization ratio below 30% will improve your score, but getting this ratio below 10% is optimal.
You can lower your credit utilization ratio by paying debt or getting a higher credit limit. Asking for a higher credit limit will trigger a hard inquiry, an event that has a short-term negative impact on your score. If you consistently pay down your debt and don’t have a balance, requesting a higher credit limit isn’t necessary. Owing $0 in debt always results in a 0% credit utilization ratio, regardless of your credit limit.