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July 17, 2013

Building a Bad*ss Credit Score: A Silver Lining Playbook for Student Loan Borrowers

I may not have two dimes to rub together, but my credit score is through the roof!  How’d I do it?  By borrowing young, borrowing a lot, and making zillions of teeny, tiny payments.  On time.  Every time.  Ever since.  (BTW, a better plan is to minimize your borrowing and pay back debt quickly to avoid higher interest fees and lower your costs over time.  Um.  If you can afford that). 

Credit Report vs. Credit Score

Your “credit report” is a history of your credit accounts that includes information on where you live, how you pay your bills, and whether you’ve been sued or have filed for bankruptcy.  

"The Big Three" credit reporting companies (Equifax, Experian, TransUnion) sell the information in your credit report to creditors, insurers, employers, and other businesses that use it to evaluate an alarming number of things that are important to you (like your applications for credit, housing, and employment). 

Everybody can (and should) review their own credit report by downloading it at annualcreditreport.com

Credit score” is a three-digit number intended to predict whether you will pay your bills over the next couple of years.  A high credit score helps you get access to good interest rates.  FICO is one of the companies that traffics in credit scores.  According to myFICO.com, "90 percent of all financial institutions in the U.S. use FICO scores in their decision-making process."  FICO assigns scores ranging from 300 to 850.

Although your credit score can have a lot of power in your life, you don’t have a legal right to access your credit score for free.  Credit scores are calculated based on secret formulas (not unlike my guacamole recipe).  We know that the secret formula includes information from your “credit report” (just as we know that a guacamole recipe is bound to feature avocados), but the actual algorithm is shrouded in secrecy.  

How do your student loans impact your credit score?

A student loan is categorized as “installment” credit (not “revolving” credit like credit cards).  All installment loans, including student loans, impact credit scores in terms of:

  • payment history,
  • amount owed,
  • length of credit history,
  • new accounts and inquiries and
  • credit mix.

 

MyFICO credit score chart
Some factors from your credit report are weighted more heavily when determining your credit score, such as payment history.  “They” say that personal or demographic information such as age, race, address, marital status, income and employment don't affect the score. 

Payment history: (35 percent) -- Student loans can contribute to a positive payment history as long as payments are made on time.  Student loans in deferment or forbearance are considered “paid as agreed” and contribute to a positive payment history.  Late student loan payments will lower a credit score the same as late payments on any other type of account.   Late payments, delinquency, and default on student loans are all “negative payment history.”  Negative payment history will mess with your credit score for a long, long time, and is typically only required to be removed seven years following the last account activity (ten years for bankruptcies).

Amounts owed: (30 percent) -- The amount of available credit you're using on revolving accounts (like credit cards) is heavily weighted, but because student loans are an installment account, the amount owed on student loan debt does not have a significant effect on the credit score.  Still, prospective lenders will consider student loan balances when evaluating whether a borrower can manage additional debt. 

Length of credit history: (15 percent) – If you opened accounts a long time ago, that’s a good thing for your credit score. That’s why conventional credit score boosting wisdom tells us to keep old accounts open.  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 the loan is in repayment, deferred or in forbearance

Types of credit used: (10 percent) – Having success with a mix of different types of accounts is considered favorably.  A student loan can positively affect credit score by contributing to a mix of credit types, for example, if you have student loans (installment credit) and credit cards (revolving credit).

New accounts and inquiries (10 percent) – Applying for new credit can cause a slight drop in credit score when the lender makes credit inquires and when new accounts first appear on a credit report.  New student loans will have the same effect as any other new account.  Note that federal Stafford loans do not require a credit check, but PLUS loan borrowers must have no "Adverse Credit History" [kudos to astute reader Brian for catching my error, thanks].  Private student lenders will make a credit inquiry, which is considered a “hard inquiry” that can impact your score for a one-year period.  Like inquiries triggered by mortgage and car loan applications, multiple student loan inquiries made within a short period of time should only count once in your credit score (to allow consumers to “shop around” when seeking credit without penalty).  But you are avoiding private student loans anyway, right?

How will your student loans affect your ability to get a mortgage or other kinds of credit?

OK, so a high credit score based on a positive credit history helps you qualify for favorable terms on mortgages and other loans.  A low credit score can make it hard to get good loans or any loans at all. 

But your credit score isn’t the only thing that lenders consider when they evaluate your candidacy for their money.  They want to know that you can afford to make your payments on the new mortgage (or car loan, or whatever).  If you owe a boatload of money on student loans or anything else, even if you always pay on time, the lender is absolutely going to factor your indebtedness into their assessment of your ability to make additional debt payments.  Unlike when you borrowed student loans, the bank will consider whether you are making enough money to pay your mortgage payment every month (Income-Debt Ratio).  If you’re not, they aren’t likely to approve you.

Sources for more information:

consumer.ftc.gov

mymoney.gov

bankrate.com

myfico.com

credit.com

Get your free credit report by downloading it at annualcreditreport.com.  Technophobes can call 1-877-322-8228 or complete the Annual Credit Report Request Form and mail it to:
Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.


Heather’s Super-Secret Guacamole Recipe

  • Squish up two or three ripe avocados using the back of a fork.
  • Add a few generous shakes of garlic powder, some black pepper, and a little more salt than you’d think.
  • Enjoy with chips and beer (I prefer Dos XX Amber with lime, but that's just me).

[You will be tempted, but DO NOT add sour cream, lime juice, cilantro, or other “ingredients.”  The only additional optional ingredient I sometimes use is some New Mexico green chile or a minced jalapeño.]

By Heather | Category: Student Debt, Student Loan Repayment  
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