For many young people, obtaining credit can be difficult, particularly since the Credit CARD Act of 2009 reined in many of the marketing efforts directed at students by credit card issuers. Yet one of the often-overlooked positive aspects of those “good old days” (for card issuers) was that those credit cards helped develop some first-time credit history — both good and bad — for many young consumers who might not have been able to establish credit otherwise.
These days, credit cards seem to be taking a back seat to student loans, as U.S. student loan debt now exceeds $1 trillion and makes up a greater proportion of consumer debt than credit cards. For many, a student loan is now the first step toward establishing the personal financial track record known as a credit score.
While perhaps small consolation for students and graduates drowning in student loan debt, one positive feature of student loans is that they can provide an effective way to establish and build credit without the help of mom, dad or a credit card.
To qualify for a FICO credit score — the credit score most lenders still use — all that’s needed is a credit account of any type (cards, loans) with at least six months of history that has been reported by the lender to the credit bureau within the past six months. This includes deferred federal or private student loans, where no payment has yet been required, as well as student loans in forbearance .
To the credit scoring formulas, a student loan is considered “installment” credit; one of the primary credit types, along with revolving (cards) and open credit (charge cards). Most installment loans, whether student, auto, or even mortgage, tend to impact credit scores similarly across all of the major scoring categories: payment history, amount owed, length of credit history, new accounts, inquiries and credit mix.
Payment history. A positive student loan payment history, including loans in a deferred or forbearance status, can provide as much benefit to a credit score as any other type of well-managed credit account. Consequently, late student loan payments can hurt a score as much as late payments on any other type of account. Student loans in deferred or forbearance status are generally treated as being “paid as agreed” for scoring purposes.
Amount owed. Here is where student loan debt differs most from credit card debt, as it carries little of the impact that revolving (credit card) balances have on scores. While student loan balances comprising a high percentage of the original loan amount — whether newly opened or deferred — can negatively impact a score by a few points in some situations, for the most part, the amount of student loan debt has little bearing on credit scores.
Length of credit history. The age of a student loan, as measured by the number of months since the open date, is factored into credit scores no differently than any other type of credit account, whether in repayment, deferred or forbearance status.
New accounts. A newly opened student loan, like any other new account, can cause at least a slight drop in score when first appearing on the credit report. This impact can also be felt from multiple disbursements of a single loan if reported as separate “trade lines” with different open dates.
Inquiries. Most inquiries related to a new student loan are considered “hard” inquiries — meaning they can impact your score. However, like inquiries resulting from new auto and mortgage loan applications, student loan inquiries are usually “deduplicated,” such that you can incur any number within a certain period of time — typically 14 to 45 days — and only one will count in the score. And, as with all hard inquiries, none are considered after one year.
Credit mix. For the student loan borrower who also has a credit card or two, simply the presence of a student loan on the credit report can positively contribute to her score by helping demonstrate the ability to manage different types of credit.
Finding a ray of positive light when talking about student loans these days is not easy. However, for the young person just getting started in adulthood and looking to build credit, a student loan can provide all the credit needed to establish a good — or bad, for that matter — credit score.
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