We've all heard the daunting numbers: The United States now holds $1.2 trillion in collective student loan debt, and this year's college graduates are leaving school with an average debt of $33,000, according to Mark Kantrowitz, senior vice president and publisher of Edvisors.com, a paying for college resource.
But college-bound students and their parents need not despair. Student loans -- when handled correctly and responsibly -- can actually serve as a major asset in building a student's credit history and credit score. They can result in a graduate being able to qualify for his or her first apartment, first car loan and, very often, first unsecured credit card.
Paying off student loans is an effective way (and often, the only way) for young people to boost their credit scores. In other words, there is a silver lining to student debt.
How do my student loans affect my credit score?
As with most other loans, you can give your credit score the biggest boost by making your student loan payments on time. It's worth noting that student loans are typically treated as installment plans by the three major credit bureaus -- Experian, TransUnion and Equifax. So if you pay your student loans in full and on time each month, the credit bureaus will make a record of that on a continuing, 30-day basis. And that will demonstrate to future lenders that you can be trusted to handle money responsibly.
Loan default should only be considered in the direst of circumstances -- when you can find no other alternative. Defaulting often triggers serious repercussions that could leave you with a damaged credit history and seriously impede your ability to get started in life as a working adult. In states where it is legal, employers may even check a job applicant's credit report before making a final job offer.
If you find yourself in a situation where you aren't earning enough money to make your monthly student loan payments, it's better to contact your lenders and ask for a deferment. But if you default on your loans, you may lose your right to defer payments. You also could become ineligible for future financial aid, which could really hurt you if you have plans to attend graduate, law or medical school.
Will deferment hurt my credit score?
In short, no. A lot of recent graduates can barely make rent, let alone have the money to pay back colossal student loans. Opting to defer on student loans, while not as ideal as repaying them because it simply delays the inevitable, won't hurt your credit score. In fact, financial institutions may take your deferment into account when deciding whether or not to approve your loan request. Lenders may come to the conclusion that you have enough money to pay back the loan they are offering you, since part of your income wouldn't have to go toward repaying student loans immediately.
At the end of the day, your credit score benefits the most from on-time, regular student loan repayments. Practicing the same good judgment and smarts that got you into college in the first place will also go a long way when it comes to repaying your student loans. As a good rule of thumb, remember that it's OK to defer, but not to default.
Hold on, what is a credit score?
Used by lenders (banks and credit unions) to evaluate a borrower's creditworthiness, a credit score is a number between 300 and 850. Of course, it's not just a number -- a credit score actually holds a lot of power in that it can also influence how high or low your interest rates are on loans. The Fair Isaac Corporation publishes these scores, which is why they're also known as FICO credit scores, and the three credit bureaus use them as well. The higher your credit score, the better, and the more likely you are to qualify for lower interest rates on other loans.
A number of factors determine your credit score, such as whether you pay your bills on time and how much money you currently owe. Financial institutions, automobile dealerships and retail department stores typically reject loan requests from people with especially low credit scores. Although some argue that reducing your creditworthiness down to a number is too simplistic, at the end of the day, that's just how it works. Maintaining a strong credit score (or at least gradually improving it if it's low) is crucial.
Fortunately, since credit scores can fluctuate on a monthly basis, it's possible to improve them from one month to the next. For example, if you don't pay your credit card bill in full in May, but then pay it in its entirety in June, that good lending behavior would be reflected in an improved credit score. That's because a credit score also reflects the outstanding balance on a credit card compared with the overall credit limit. So if you have incurred charges of $250 on a card with a credit limit of $1,200, that would give you a better score than if you had maxed out the same card with $1,150 in charges.
Since students usually don't have extensive credit histories, it can be tough, for instance, to get a car loan with a reasonable interest rate. Paying back your student loans on time can help bolster your credit score and get you a better interest rate. And that could save you hundreds, if not thousands, of dollars down the road, as a lower interest rate will typically result in lower monthly payments.
After spending four years stressing out about your GPA, your credit score shouldn't become your newest three-digit obsession. That said, you should know what it is, and take steps toward improving it if it needs a boost.
Divya Raghavan writes for NerdWallet, a financial literacy and consumer advocacy website. NerdWallet creates tools and resources that empower consumers to make smarter financial decisions, offering everything from a credit card comparison to a cost of living calculator.