Student loans help millions of Americans afford to go to college every year. While student loan debt certainly isn’t something to take lightly, there’s no doubt that student loans can have a positive effect on your life and your employment prospects.
But let’s take a look beyond what student loans can help you do around the classroom and examine their effect on your credit. Simply put, student loans are like any other loan out there. If you’re responsible and if you make regular, on-time payments, they can absolutely help build your credit score.
That said, there’s plenty to be wary of when it comes to your student loans and how they’ll affect your credit score. Read on and let’s take a deeper dive to make sure that you come out ahead.
Types of student loans
First, let’s take a second to break down the different kinds of loans available first. There are 2 main kinds of student loans available to undergraduates: federal direct student loans and private student loans. You’ll also find both subsidized and unsubsidized loans.
Federal student loans
Federal loans are provided by the government and are either subsidized or unsubsidized. They don’t require income, credit history, or a co-signer to apply. They also have flat interest rates set by Congress and more options for repayment than private loans. Whenever possible, use the federal direct loans available to you before looking for other options to pay for college.
Private student loans
Private student loans are offered by banks, credit unions or online lenders. Avoid taking out loans from private lenders if possible. They typically have higher interest rates and worse repayment terms that can put you in massive debt before you’re done with college. If you do need to explore options outside federal loans, it’s important to be aware of a few things about private student loans. Because private lenders consider your credit score and income, you’ll usually need a parent or guardian to co-sign the loan since most undergrads don’t have a credit history or stable income yet.
Subsidized and unsubsidized loans
Subsidized loans are available from the federal government to undergraduates with financial needs. The government pays interest on them while you’re in college, during your grace period (usually 6 months after you graduate) or during periods where your payments have been paused (due to unemployment or part-time schooling).
Unsubsidized loans are available to all undergrads regardless of financial need. Here, the government doesn’t pay the interest that accrues on them while you’re in college. You’re responsible for paying all the interest that accrues during the life of the loan. There’s a cap on how much money you can borrow for both subsidized and unsubsidized loans. No matter what, make sure you use the federal direct loans that are available to you first.
How student loans impact your credit
All this in mind, remember that student loans have the potential to positively impact your credit and set you up for a successful financial future if you make payments on time and in full. Understood and used correctly, student loans cannot only help you get through your education - they can also jump-start your good financial reputation.
Most loans have repayment plans ranging from 10 to 30 years, which boosts your average age of accounts and your credit score if you make payments on time and in full. Lenders see you as a less potentially risky buyer than people with shorter or nonexistent credit histories. If you can take on a big investment like student loans, you can prove you’re financially responsible with each payment you make.
Another way lenders evaluate your risk as a borrower is by looking at the kinds of credit in your profile, like revolving accounts and installment loans. Credit cards are an example of revolving accounts. They require a minimum balance to be paid, which, if unpaid, rolls into the next payment with no definite end date. Student loans are an example of installment loans, which have predetermined (usually monthly) payments with a set end date. If you don’t already have an installment loan (like an auto loan) on your profile, your student loans cover this category. Paying on time and in full for your loans lowers your perceived risk as a borrower.
Encouraging regular payments
Your payment history makes up the biggest part of your credit profile, so there’s nothing more important than making regular payments if you want to boost your score.
Making regular payments also protects you from paying higher interest or late fees for missed or late payments. It lowers your debt-to-income ratio, which further demonstrates your responsibility in finances. And since student loans typically have very defined repayment terms, it can be easier to develop a plan for paying them off than, say, a credit card, where the balance you owe will vary from month to month.
Other factors to consider
Even though student loans are a powerful tool to get you through college and into your long-term career, there are other downsides to consider. You’ve probably heard stories of people graduating from their dream colleges only to finish school with thousands - even hundreds of thousands - of dollars of debt attached to their names. We don’t want you to end up in that situation, so it’s important to be wary of potential downsides.
If you fail to make on-time payments on your loans, your credit score can suffer. If you miss multiple payments, your loan is at risk of going into default. Defaulting occurs when the borrower stops making payments on their loan.
If you’re in default, your future access to credit or loans is likely to be much more limited. For federal loans, you’ll move into default 270 days after the first missed payment. For private loans, your lenders can report your default to the credit bureaus after only 90 days.
At this point, even payments made while your loan is in default can hurt your credit score, too. Defaulting is perhaps the action most capable of harming your credit score when it comes to student loans. There’s not much wiggle room, so it’s essential to stay on top of your payments and avoid private lenders when possible.
The last thing you want after graduating from college is to realize you owe half of what you borrowed in interest, too. While interest isn’t the only factor that contributes to student debt, it’s one of the biggest.
Some loans, like federal direct subsidized loans, don’t require you to pay interest until you’ve graduated (which is why they’re usually the best option among your loan choices). But others, especially private loans, operate using compound interest, meaning you pay interest on what you borrowed originally and the interest you’ve already accrued. If you don’t make payments or make minimum payments, the amount of money accruing interest grows quickly.
Because of interest rates, you could end up paying hundreds or thousands more over the life of the loan. To avoid this, it’s important to understand the kind of loan you’re borrowing and the interest rates that come with it.
Fizz is here to help
Whether you’re halfway through college or just starting out, we want to help you build good credit so you’re prepared for your future and better able to secure better terms for your student loans and future loans. When you sign up for a Fizz card, you keep spending money the way you normally would, except you build credit while doing so. We never charge interest or extra fees and we don’t check your credit score when you sign up. Take the next step to prepare for the future and download the Fizz app today!
Sam is a Kenyon College alum and is head of content at Fizz. He's been a go to personal finance resource among his peers since getting his first credit card during his sophomore year of college. He hails from Washington, DC, loves all things aviation, and currently lives in Los Angeles.