When talking with friends, I hear this sort of statement all the time: “I’ve been paying my student loans on time for years now; why isn’t my credit score going up?”
It’s an important question! And one that takes some digging to get the answer to.
A couple truths
Before continuing, here are a couple things that are true.
- Having good credit is important. My credit score determines the interest rate I’ll borrow at when buying homes, cars, and other things. Not only that, bad credit may make it tough get a cell phone, rent an apartment, or even secure a job because one in seven employers checks applicants’ credit reports. (Source: MSN)
- Less debt is better than more debt. To use specific numbers, being $100 in debt is better than being $200 in debt. An extension of this truth is that no debt is better than some debt and there are many reasons why I should pay off debt.
Student loans are installment loans
My credit score is determined by the three consumer reporting agencies (or credit bureaus), who look at a number of factors to come up with the number, including the following five (Source: Equifax):
- The number of accounts I have.
- The types of accounts.
- My available credit.
- The length of my credit history.
- My payment history.
Student loans really come into play under #2 and #3 (and #5, but I’ll discuss that later).
Under #2, the two types of accounts are revolving credit and installment credit.
- Revolving credit is an arrangement where I have a set limit up to which I can borrow, which once repaid can be re-borrowed again until the terms of the arrangement expire. Credit cards are an example of revolving credit.
- Installment credit is made up of loans for a fixed amount of money, paid off under terms set when I get the loan.
Student loans fit into installment credit.
Now, under #3, my available credit is measured by looking at my balance-to-limit ratio, which compares, as a percentage, the money I’ve borrowed to the limits I’m allowed to borrow. Obviously, a lower percentage is better here. Importantly, according to the consumer reporting agencies, the “balance-to-limit ratio applies only to revolving accounts.” (Source: Experian)
And this answers my friends’ original question; paying off your student loans on time doesn’t make your credit score go up very much because your student loan balances don’t factor into your balance-to-limit ratio.
And now, to go back to the second of my truths, there are many great reasons that I should pay off my student loans and even do so early; however, that it might increase my credit score isn’t one of them.
Student loan delinquency is treated like any other delinquency
Wait, but that’s not really the end of the question, because there is a way that student loans can affect your credit score.
Going back to #5 on the list of things that make up your credit score, your payment history is determined by how many accounts of yours go delinquent.
The Department of Education considers your student loan delinquent as soon as you miss a payment, and your loan servicers report all delinquencies of at least 90 days to the three consumer reporting agencies. (Source: Ed)
And once those consumer reporting agencies know about a delinquency, they’ll keep it on your credit report for seven years. (Source: Experian)
In other words, while making student loan payments on time may not help your credit score very much, missing student loan payments can hurt your credit score a whole lot.
Welp, have a great day!