Student Loans and Credit Scores
Discussing family accounts as a way to build credit, it was mentioned that people starting out will usually have student loans as their first credit account, unless they obtain a car loan or credit cards tied to a family member with credit history. Student loans are a tricky area of installment credit history because they are not looked on as favorably as you would imagine.
You might think that having opened student loan accounts when you first went to college would show a history of the account, but in actuality, only when you start making your first payment will student loans count as “credit payment history.” Most student loans are in a deferred status as long as you are in school. Once you are out of school, you have one to four months before the companies begin asking you to make monthly payments that pay down the principal and interest.
Yet, when you have student loans, you have an “amount owed.” This amount owed can actually be reducing your credit scores. One the one hand, you feel that making payments should increase your scores, but then you get dinged for having a high amount owed.
So what can you reasonably do about student loan debt? Do you want to pay it off right away?
According to people like Stephen Snyder and Robert Kiyosaki, if you have student loan debt, you want to leave it as the last items you pay off. It comes down to an IRS strategy. The history of this strategy has existed since student loans became necessary for people to go to college. The minute the IRS allowed you to use your student loan interest paid as a deduction is when this strategy came into being.
How it Works
- Each month you make a payment you pay interest and a little towards your principal, when you are newly paying on the account.
- When you file taxes, you are asked to enter the amount in student loan interest you paid.
- The amount paid is a deduction.
- During this same period, you are paying a little of the “amount owed,” thus reducing your overall debt amount.
- You are also making payments, and as long as they are on time and the full monthly amount, you are helping your scores.
- When you get to a point in the loan, where you are barely making any interest payment at all towards the balance, pay off the debt.
Student loans, when you first start taking them out appear on your credit report, but without any payment history. It is just an open installment account. The lack of payment history does not help your score, nor does it hurt it. The debt utilization ratio on the other hand will hurt your score a little. It is due to having this debt that makes your score a little lower than if you had no debt at all.
If this is the only debt you have, then it is also considered “little to no debt,” which also does not help when you are trying to get new loans to build your credit history.
When it comes time to make payments to the student loan companies as part of your installment agreement, you need to be on time and pay the monthly amount asked for. If possible, pay more than the monthly amount.
Paying interest helps lower your taxes owed. You want this deduction and the payment history. The deduction may be the only thing you have helping you get a tax refund. The payment history is also helping you increase your score, as the balance goes down.
There will come a point when you are going to pay off the debt in full. Do this when the deduction on your taxes is no longer significant. The reduction of debt owed will also help at this point. The reason behind this key point lies in the other credit you have built. You should be in your 30s or 40s, with a mortgage, credit cards, and other credit that weighs more significantly on your ability to get credit. You no longer need the payment history from the student loans. In fact, given the amount of debt you might have at this point, you want to reduce the “amount owed” you have overall.