When you are just applying to colleges and you desperately need the extra money to fund your education, it’s tempting to take out the maximum loan amount just so you can attend your dream college. It is important to understand the impact your student loans could have on your credit score, and how it can ultimately affect your financial future.
Why Is Your Credit Score So Important?
Sometime in the not-too-far-away future, when you have graduated and are looking for a job, a car and your very own home, that credit score that you had completely forgotten about, will raise its ugly head.
When you are looking for finance to buy a car or a home, your credit will be checked. You may not be aware of it but all lenders will want to see your credit history before lending you any money. Why do they do this? Well, good credit history means you are a responsible borrower—a favorite type with lenders because they know you can be trusted to make your payments on time. With good credit history, you will find it easy to secure a loan for any purpose, whether it is to buy a car or to put a down payment on a home.
If your credit history is not so stellar, you will have a completely different experience when you try to get a loan for any purpose. Most lenders are reluctant to loan money to anyone with a bad credit score because it means you are an irresponsible borrower. In most cases, they will simply reject your application. Even if they do agree to loan you money, it will come with much higher interest rates.
It may not be as common, but some employers use applicants’ credit history as one of the deciding factors when hiring employees. They want to make sure that you do not have financial problems, which could affect your efficiency on the job. Employees who are responsible with their finances can stay focused on the job instead of worrying about how they are going to stretch their income to cover all their expenses.
Now that you know why your credit score is so important, here’s a look at how your student loans can affect it.
Loan Payments Are A Major Factor
When it comes to student loans, there are various factors that can affect your credit score, but the biggest of them all is related to your loan payments. Approximately 1/3rd of your FICO score depends on your payment history.
When you took the loan, you would have agreed to pay back a certain amount on a fixed date every month. To keep a good credit history spotless, it is absolutely critical that you make that payment on time, every month.
Most students know that they will end up paying a stiff fine if they are late on even a single payment but what many students do not know is that single late payment can also adversely affect their credit score. It does not matter why you did not make the payment on time, whether you simply forgot or you did not have the money to pay the loan one particular month, it only takes one ‘past due date’ report to end up defaulting on your student loans and to get a black mark on your credit history. This will cause your credit score to drop, which can create several problems if you ever need to borrow money again.
A Couple Of Things You Should Know About Student Loans And Your Credit Score
It does not matter if you have taken federal or private student loans. Both types of loans are treated the same when it comes to calculating your credit score.
Taking more student loans will not necessarily hurt your credit. Student loans are treated as installment loans. With installment loans, how much you have borrowed does not matter. What matters is whether or not the payments are being made on schedule.
There is a caveat to this though—while your credit score may not be affected by your balances, if your debt-to-income ratio is too high, you may find it difficult to borrow any more money. A high income-based debt-to-income ratio means you have too much debt as compared to your monthly income so you are already struggling to pay your current loan. Most lenders will turn down your loan request under these circumstances.
What You Can Do To Keep Your Credit History Spotless
There are several things you can do to protect your credit history but the most important is to make your payments on time, every time. As we saw earlier, late payments create the biggest impact on your credit score. With that in mind, the single best thing you can do to protect your credit history is to make sure you make all your payments on time, every month.
If your payments are late because you have trouble keeping track of the payment dates for multiple loans, it’s time to stop relying solely on your memory and start using either a digital or paper planner. With the due dates and amounts written down, you are less likely to forget. Another option is to set up an automatic payment plan so your payments go out automatically every month. As a bonus you may even get a discount on your interest rate. That itself makes it worth it.
If your payments are late because you cannot afford the amount, you must take to your lender as soon as possible and find out what your alternatives are. You may be able to refinance or consolidate your loans or even apply for an income-based repayment plan. When it comes to protecting your credit history, loan deferment is one option that may be a far better alternative to late payments.
Take time to consider what will work best for you given your financial circumstances rather than just hoping something will work out. It rarely does. On the other hand, taking the trouble to protect your credit score can pay rich dividends later down the line by way of higher loan eligibility, lower interest rates and more.
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