Do student loans affect credit utilization? When it comes to managing your finances, it’s essential to understand how different types of debt affect your credit score. One type of debt that can significantly impact your credit score is student loans. In this blog post, we explore whether student loans affect student loan usage, what college credit usage is, and what you can do to manage your student debt responsibly.
What is credit utilization?
Credit utilization refers to the amount of available credit you are using at any given time. For example, if you have a credit card with a limit of $10,000 and a balance of $5,000, your credit utilization rate is 50%. Your credit utilization ratio is a critical factor in determining your credit score, accounting for 30% of your FICO credit score.
Do Student Loans Affect Credit Utilization?
Do student loans affect credit utilization? The short answer is no, student loan debt does not directly affect your credit utilization. Unlike credit card debt, which affects your credit utilization once you use your card, student loan debt is not considered part of your available credit.
However, that doesn’t mean student loan debt doesn’t affect your credit score in other ways. Late payments or defaults on your student loans can affect your credit score, which in turn can affect your credit utilization. Late payments and delinquencies can stay on your credit report for up to seven years and can hurt your credit score.
5 Ways Student Loans Can Affect Your Credit Score
There are several credit score models in use today; the two most popular are FICO® and VantageScore. Both use a scale ranging from 300 to 850. A higher score indicates a greater degree of financial responsibility.
Here’s a closer look at how your student loans can affect all of these factors.
1. Payment history
Your payment history is the most important factor that determines your credit score. It accounts for 35% of your FICO® score, which is the most commonly used by lenders. Payment history is an important measure of financial responsibility, and not paying off your debt on time can indicate that you are living beyond your means. And that means you run the risk of defaulting.
The effect of a late payment depends on how late the payment was and your current credit score. Creditors generally don’t report late payments until they’re 30 days late, and payments that are 60 or 90 days late will hurt your score more than a payment that’s 30 days late.
It may seem counterintuitive, but the higher your credit score, the more a late payment will hurt you. FICO® says a single 30-day late payment can lower a 780 score by more than 100 points. If your score is lower, there’s not much to lose in the beginning. So a late payment can’t hurt your credit score that much.
If you miss enough payments to stop paying your student loan, it will also show up on your credit report. And it will stay there for seven years. This destroys your ability to obtain new loans and lines of credit. Fortunately, if you have a federal student loan, you may be able to rehabilitate it and remove the default from your credit history.
A good payment history helps improve your credit score. If you make at least the minimum payment each month before the due date, your credit score will begin to rise. This is a great way to qualify as a responsible payer and make it easier to get new loans and lines of credit.
2. Credit Utilization Ratio
Your credit utilization ratio is the percentage of your total available credit that you use. This is especially true for revolving debt, such as credit cards, where you can borrow up to a certain amount each month.
If you have a $10,000 credit limit and use $2,000 per month, your credit utilization ratio is 20%. But student loan debt is considered an installment debt because of your regular monthly payments. Installment debt has less impact on your credit utilization ratio.
It will still affect your score to some degree, especially early on when most of your student loan debt is still outstanding. But carrying $20,000 in student loans won’t hurt you as much as $20,000 in credit card debt.
As long as you keep your revolving credit utilization low and don’t have too many other loans taken out at the same time, you don’t have to worry about the impact of your student loans on your credit utilization.
3. Length of credit history
Your credit report records how long you’ve been using credit and how long your credit accounts have been open. Lenders like to see a long credit history because it gives them a better idea of how well you handle your money.
Getting student loans allows you to start building your credit history early. The standard repayment term for a federal student loan is 10 years, so the loan will stay on your credit score for a long time. This helps increase the average age of your account.
But that doesn’t mean you shouldn’t pay off your student loans early if you can. The small boost it can give your credit score probably isn’t worth all the extra interest you’ll pay if you only make the minimum payment.
4. Credits Mix
As I mentioned earlier, credit is divided into two types: revolving debt and term debt.
The most common form of revolving debt is credit cards. This allows you to borrow up to a certain amount, but the actual amount you borrow may vary from month to month. Instalment debt, on the other hand, has predictable monthly payments over some time. Student loans fall into this category, as do mortgages, car loans, and personal loans.
Having revolving and instalment debt gives your credit score a slight boost by showing that you can be responsible with different types of debt. Many students have credit cards, and student loans can add instalment debt to the mix.
Having a good credit mix has only a small impact on your credit score. But it’s an easy way to earn some extra points.
5. Number of hard inquiries
When you apply for a student loan or other type of credit, the lender conducts a thorough investigation of your credit report. This is where they retrieve your credit reports to assess your financial responsibility. Unlike a soft credit search, which has no impact on your credit score, a hard credit search will lower your score by a few points.
Lenders understand that borrowers shop and compare rates when applying for a loan or line of credit, so most credit score models consider all questions within a 30-45 day period as one question. Keep this in mind when buying student loans and try to submit all your applications within a month of each other so that you don’t end up with multiple questions about your report.
How To Manage Your Student Debt?
While student loan debt may not directly affect your credit utilization, it is still important to manage your student loan debt responsibly to avoid negative consequences for your credit score. Here are some tips to help you manage your student debt:
- Paying on time: Paying on time is one of the most critical factors in maintaining a good credit score. Set up automatic payments to make sure you never miss a payment.
- Avoid default: Defaulting on your student loans can seriously affect your credit score and lead to wage garnishment or legal action. If you’re having trouble making your payments, consider signing up for a means-tested instalment plan.
- Pay more than the minimum: If possible, pay more than the minimum each month to pay off your loans faster and lower the total interest you pay.
- Refinance Your Loans: By refinancing your student loans, you can get a lower interest rate and lower your monthly payment.
Conclusion – Do Student Loans Affect Credit Utilization
Do student loans affect credit utilization? While student loan debt doesn’t directly affect your credit utilization, managing your student loans responsibly is still essential to maintaining a good credit score. By paying on time, avoiding default, paying more than the minimum, and refinancing your loans, you can manage your student debt and avoid any negative impact on your credit score. By doing this, you can set yourself up for a successful financial future.
