Student Loans and Managing Your Credit Score
December 17, 2015
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Here are some ways you can manage or mitigate a student loan’s effect on your FICO score.

Borrowing to finance education costs can be a great bet in the long run. In fact, most studies show that a college degree does, in fact, pay off handsomely over the course of a career compared to the cost of tuition. But your student loan balance will affect your credit in the meantime.

Here are some ways you can manage or mitigate a student loan’s effect on your FICO score.

1.) Try to do your student loan shopping within a short time period. Too many applications for credit will hurt your credit score. But the Fair, Isaac Corporation (FICO), the company that calculates consumer credit scores and markets them to lenders, knows that people shop around for credit and put in multiple applications to get the best loan rate for a house, vehicle, or even a college education.  According to FICO, multiple applications made within 30 days prior to scoring for auto, mortgage and student loans are treated as a single inquiry. These application will have little or no impact on your credit score. Therefore, if you bunch your applications within about a 30-day time period, the negative impact on your credit score will be minimal.

2.) Keep monthly payments low. That monthly payment you make to Sallie Mae or any other lender counts against you when it comes to calculating your credit score. When you apply for, say, a car loan or mortgage on a house, underwriters will generally want to know your ‘debt to income’ ratio. That is, what percentage of your total income is  committed to debt payments. That’s a pretty good measure of your capacity to absorb additional debt and still make the payments. For example, to qualify for an FHA mortgage, your total debt to income ratio, taking all your credit accounts into consideration (your so-called “back-end” ratio) generally cannot be higher than 41 percent. That is, if you make $5,000 per month, your total debt payments, including your student loan payment, cannot be higher than $2,050, without special authorization from the lender. Your student loan payments get counted against that $2,050 income limit.

But if your college education helps you increase your income, you get the benefit of that, too. So college debt can be a double-edged sword. It can help you increase your income and therefore increase your access to credit. But if you don’t graduate, or your degree or certificate just isn’t very lucrative, you could get left holding the bag.

3.) Pay on time. Being unorganized can kill you here: FICO states that your record of paying your obligations on time, with few or no late payments, is the largest single factor that goes into your credit score, at 35 percent.

4.) Don’t max out your credit cards. Lenders look at the total amount you owe, yes, but they also look at the available credit limit, as well. Both figures go into a metric called your ‘credit utilization ratio.’ This is simply your total balance owed divided by your credit limit. If you are close to your credit limit, you don’t have much flexibility left in the event of an economic setback. You are, in their view, a riskier lender.

The bean counters who track these things have noticed that people with very high credit utilization ratios are statistically much more likely to default on one or more credit accounts within the next two years than people with lower credit utilization ratios.

So don’t load up on available credit. Keep some significant headroom between your balance owed and your maximum available credit.

5.) Don’t just close accounts, willy-nilly. There’s nothing wrong with cutting up your credit cards to beat the debt habit. But if the objective is the short-to-medium-term improvement in your credit score, just closing accounts can be counterproductive. First, it will almost certainly raise your credit utilization rate, which can drag down your score. Second, the age of your credit accounts is one of the factors in your score. Older accounts that you’ve paid faithfully on time for many years are good for your FICO score. It doesn’t help you to close them out.

6.) It’s better to pay debt down than transfer it. Don’t make a strategy out of just moving debt around. Making some strategic moves to refinance debt or transfer balances to a lower interest rate is fine. But don’t just roll balances from one card to another. If you want to improve your credit score, pay on time, and pay it down.

7.) Don’t open new accounts unless you need to. Yes, you may improve your credit utilization ratio by taking out several new credit cards and a car loan. But FICO is wise to this ploy. This tactic is likely to lower your score, rather than raise it.

8.) Don’t go bankrupt. Yes, there are times when consumers have little choice. But a bankruptcy has an immediate and heavy effect on a credit score – especially if you had a good score right before the bankruptcy. The more different accounts affected by the bankruptcy, the greater the negative impact on your score.

While old debts remain on your credit history for seven years, Chapter 7 bankruptcy stays on your credit report for 10 years – and some employers will ask you if you have ever declared bankruptcy.

At any rate, federally-guaranteed student loans are not normally discharged in bankruptcy anyway. If your major cash flow problem is your student loan payment, bankruptcy is unlikely to be the solution. Contact your loan servicer. They usually have a number of options for struggling debtors to choose from short of defaulting, and short of bankruptcy.

9.) Check your credit report periodically for errors. They do happen. You can’t get accurate information expunged from your credit report – don’t believe anyone who tells you they can if you pay them a fee. But you can challenge inaccurate information. Here are several resources put out by the Fair, Isaac Corporation to help you deal with mistaken information, credit management and identity theft.