Do Student Loans Build Credit?

You can get approved for a student loan much easier than any other type of advance or line of credit. Additionally, your income and credit score don’t impact your ability to get approved for federal funding. But how do student loans affect credit score points? Moreover, do student loans build credit when you make payments on time?

If done the right way, borrowers can certainly boost their FICO score. However, without a carefully planned strategy, the consequences are detrimental. Because most students only pay back their loans after graduation, many of them delay their plans and preparations. As result, if their income makes it difficult to make the payments, they could be stuck with accruing interest and, even more importantly, a declining credit score. In short, this would make life after college messy and financially burdensome.

Nevertheless, an effective plan has the opposite impact. Not only does it enable you to build credit, but tuition lenders are much more lenient than traditional financial institutions. Above all else, student loans may even help you qualify for other lines of credit.

Direct and Indirect Impacts: How do student loans affect credit score outcomes?

Do student loans build credit?

Firstly, just as with any other type of borrowing, making on-time payments certainly boosts your credit. About 35% of your FICO score is based on your payment history, to begin with.

To clarify, FICO is one of the main models used to calculate consumers’ credit scores.

In fact, a student loan may even give you a head start. Most of the time, getting approved for a mortgage, car installment, or line of credit is difficult, especially when you’re a young recent college graduate.

Since your rent and bills don’t count towards your credit, a student loan is a readily available way to prove your ability to pay back lenders. Otherwise, you may have to wait until you qualify for a mortgage or car loan in order to demonstrate this. The process would take years.

Indirect Credit Worthiness

A person’s degree or level of education isn’t part of their FICO score. However, it does help you qualify for loans in an indirect way.

When a lender considers a potential borrower, they look at their income and work history, alongside the credit score. A recent college graduate will likely have little-to-no professional experience.

Nevertheless, their degree makes up for that, particularly when it’s related to their line of work.

If a student gets a bachelor’s degree in finance, for example, and, after that, they find employment with a bank, a lender looks at that favorably.

This demonstrates consistency and shows that the borrower can maintain their line of work or profession. In other words, when you have a degree, it indicates that you are more likely to honor your loan’s payments.

How do student loans affect credit score calculations?

Hard Inquiries

When you apply for any loan or credit card and the lender runs your background check, this shows up on your score. More specifically, every hard inquiry docks a few points.

Student loans, meanwhile, are different. If you are still in high school and plan on starting your college journey next year, you can shop around and compare what different lenders have to offer without worrying about the negative impact of hard inquiries.

Doing so within a short period of time, such as 30 days, doesn’t take any points off your score. This is true regardless of how many lenders screen your background, as long as you apply during a condensed timeframe.

Diversification: Do student loans build credit when combined with other methods?

College graduates and current students can further strengthen their credit score by diversifying their loans. A credit card, combined with timely student loan payments, may be the best way to approach this.

Needless to say, late payment on a line of credit can cause a lot of damage. Yet unlike borrowed money, credit cards go towards your FICO score based on how often you use them.

For example, a college student gets a $200 line of credit. If they only use 30% ($60) or less, it shows that they can responsibly handle their debt and finances. As a result, the student’s FICO score will go up when they keep their credit card utilization rate below 30%.

When this is combined with monthly payments on both the card and tuition loans, your credit score will increase even more.

Why do student loans build credit when they are used this way? Because you can demonstrate that you’re a reliable borrower and spender, alike.

When and how do student loans affect credit score points negatively?

Debt-To-Income Ratio

Alongside your FICO score, payment history, level of education, and credit card utilization, lenders carefully examine an applicant’s debt-to-income ratio.

To illustrate, let’s assume that a college graduate must pay $400 per month on their tuition loans. Moreover, another $150 goes towards their credit card. Additionally, their income from work is $2,000 per month.

In this case, their debt-to-income ratio is about one-to-four ($550-to-$2,000) or 20%. Since this number is considered somewhat low, a lender is more likely to approve them for a car loan or mortgage.

If the college graduate only made $1,500 per month, on the other hand, their debt-to-income ratio becomes well over 30% ($550-to-$1,500). As a result, lenders will consider them to be too indebted and, therefore, reject their loan application.

While this is a common concern, college degree holders may not have to worry about it. Firstly, graduates earn an average of $50,000 per year. Meanwhile, the typical annual college loan payment tends to be just below $3,500.

In short, if a graduate doesn’t have any credit cards or other payback obligations, their debt-to-income ratio is only seven precent. This makes a college degree and student loans worthwhile, at least as far as this aspect is concerned.

Concluding With Answers

Do student loans build credit?

They certainly do when you make payments on time. A college degree also raises your salary, alongside minimizing your debt-to-income ratio and boosting your credibility in the eyes of lenders.

How do student loans affect credit score calculations?

Your credit score goes up when you make timely payments, even more so when you combine them with a credit card.

Whether you’re a freshman, a college graduate, or anything in between, it’s time to make a plan. Do you want to buy a home? How soon would you like to finance a car?

If you haven’t defined your future goals, keep in mind that adulthood started about the same time as your college career, as did your credit history and financial track record.

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