Several factors can affect your credit score. Better scores tend to provide you with better interest rates for future purchases, and poorer scores tend to incur high-interest rates or tell prospective landlords that you may be unreliable. What you may not know, however, is that some forms of debt can actually help improve your credit score. It may sound counterintuitive, but there are several ways that taking out student loans, in particular, can help raise your credit score over time.
Positive credit marks from student loan history
One factor that goes into determining your credit score is your credit age. By taking out a student loan around your late teens or early twenties, you’re getting a head start on establishing a credit history. The age of your credit history is important, as this tells financial institutions how “mature” you are when it comes to utilizing credit and financing. The earlier you start establishing your credit history, the better.
Along with establishing credit history, you’ll have the opportunity to start building a good pay-off track record. Each time you make a payment on time, this builds a good foundation for your credit score. This also includes utility payments, car loans, and more. In fact, payment history can account for about 35% of your total credit score. Setting a solid foundation of timely payments is a great way to offset any accidental late payments you may make in the future.
Finally, student loans can help you achieve a higher credit score by diversifying your credit accounts. When calculating your credit score, the number of accounts in your name, as well as the type of accounts, all contribute to your portfolio diversity. Creditors want to see that you not only have a long history of utilizing credit and paying your bills on time but that you are also mature enough to handle multiple lines of credit. Beefing your score up with an additional credit card and car loan will help diversify your accounts even further. As an added bonus, you’ll be funding an education, which is a valuable investment in itself.
It should be known, though, that your score will likely drop after you first take out your student loan. Credit scores tend to lower after loans are withdrawn because you’ll have a higher credit utilization rate. However, over time, your score will improve as you establish credit history, make payments on time, and diversify your portfolio.
Responsibility is key
Sure, taking out a student loan can help your credit score. But, you’ll need to be careful with this new responsibility. Handling student loans in the wrong way can damage your score. Always make your payments on time. Your payment history still plays a big role in calculating your credit score, so even a few late payments can result in a drop of a few points. What’s more, you’ll want to avoid defaulting on your student loan at all costs. Defaulting occurs when your loan goes unpaid for more than 270 days after the initial due date. If you let your late payment go for this long, your credit score will take a nosedive. Your student loan will also likely be sent to collections, and these will affect your credit score for about seven years. What’s more, you won’t want to deal with the nasty debt collectors who will come knocking on your door.
If you’re struggling to pay back your student loans, consider refinancing. This will allow you to obtain a new loan with a new interest rate and terms. Refinancing student loans will likely lower your monthly payment and save you money on interest over time if you find the right lender.