By: Geoff Stam, Director Default Management and Financial Literacy, Office of the Chancellor
“Can student loans affect my credit? Can I get a student loan without a credit history? What happens if I do not pay my loans back?” All of those questions and more have been asked by students at one point in time or another. The simple answer is, yes, student loans can have an impact on a borrower’s credit. The measure of that impact will vary based on the loans being sought, borrowed, and how they are repaid over time. For this article let’s examine the Federal Loans in particular (Subsidized, Un-Subsidized, and PLUS). Before this goes any further, let’s add some further understanding of credit.
1. First of all, what is credit? As a financial tool, credit is one’s ability to purchase goods or services now that are paid for at a later date or over a period of time as dictated by an agreement from both parties involved in the transaction. That payment is considered at debt. The amount of credit or debit that one will be extended by a lender will typically be based on a credit score. This score is a measure of the likelihood that a borrower will pay their debt as agreed. Borrowers with higher credit scores represent a lower risk to the lender while lower scores are considered risky and likely to default on debt.
2. Do Federal loan require a credit score? No, Subsidized and Un-Subsidized Direct Loans do not require a credit score or credit check. Federal PLUS loans (for parents and grad students) do look at credit, but not a score. To qualify for PLUS loans a borrower cannot have an “adverse credit history.” As listed on Studentaid.ed.gov, the borrower must not have had a Bankruptcy discharge in the last 5 year, be more than 90 days late on any debt or having any Title IV debt (including a debt due to grant overpayment) within the past five years subjected to default determination, bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment, or write-off.
One very nice “advantage” of using Subsidized or Un-Subsidized Direct Student Loans is that for those who have never had credit in the past, this provides an easy opportunity to start a credit file using an installment type loan. For some who may have had issues previously with credit Federal Student Loans do provide an opportunity to re-establish a credit rating or assist in rebuilding a credit rating without having to complete a credit check.
3. What sort of credit is a Federal loan? Subsidized and Un-Subsidized Direct Loans are considered installment agreements in the world of credit and loans. This means that in a typically installment contract, the borrower will make the same amount of payment on a monthly basis until the amount owed is repaid. Once the final payment is made, the installment contract is completed; a new one would need to be opened to extend any further credit. Just remember, Direct Loans are a contract with the Federal Government!
4. Will Federal loans help my credit score? If you make your regularly scheduled payments on-time, yes, they will help you build and maintain a good credit score. Studentaid.ed.gov defines on-time payments as those that are received by your federal loan servicer no later than 15 days after the scheduled payment due date. A full payment is one that equals or exceeds the amount you are required to pay each month under your repayment schedule. A good payment history on your student loans will help you qualify for other forms of credit, such as mortgages or automobile loans.
5. If I don’t pay will it hurt my credit? Yes; missing payments or not paying at all, (defaulting), on your student loans absolutely will hurt your credit. Any time you apply for a loan or other form of credit, your credit report will be reviewed and a score will be produced. As stated on StudentAid.gov, a credit score is an objective measure of credit risk. It summarizes the information from your credit history into a single number. This allows lenders to compare borrowers and asses the risk of lending them money. Borrowers with higher credit scores are more likely to pay their debts on time. Fair Isaacs and Company (FICO) developed the first credit scoring model. FICO scoring is the most widely used type of scoring available today, used by about 90% of all financial institutions. The range of scores starts at 300 and extend up to 850. Typically the higher the credit score, the lower the interest rates that are offered on loans. Paying your student loans on time will certainly increase your credit score and make it easier for you to borrow loans in the future. Defaulting can reduce your FICO score anywhere from 40 points to as high as 125 points depending on what your score is today.
6. Does using a deferment or forbearance hurt my credit score? Not necessarily. A deferment or forbearance used through the Federal Student Loan program will keep you out of delinquency with the servicer and prevent you from losing points off your score for late payments. Both a deferment and a forbearance will keep you in “good standing” with your service provider. A negative of deferments and forbearances is that they both extend your repayment for the timeframe used. Each may also cost you more interest because of the delay in payment. They also have the potential to keep your debt to income ratio higher for a longer period of time due to extending the loan terms. This “cost” however, is far less than the expense of a delinquency or default to your credit report.
As the Director of Default Management and Financial Literacy, I want you to know that we are here to help you through this process. Please feel free to contact me if you have any questions. I am based at the Keiser University Jacksonville Campus and can be reached at (904) 296-3440 extension 139, or firstname.lastname@example.org. The i3 Group can be reached at 1-866-296-7955 or www.i-3group.com. You can register for a free Loanlook.com account using the referral code “KSROUT”.