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For many Canadian students, securing a loan is a necessary part of their foray into post-secondary education. Whether it’s college or university, the cost of tuition, books, supplies and in some cases relocating, can be overwhelming to take on alone.
Unlike previous generations, student loans have become the norm so it’s important to make them a key part of your financial plan and family discussion. While some may only see student loans as a financial burden, they can actually help you establish smart credit habits early on in life if they’re managed properly and paid on time. Learning more about how they can impact your credit score, both negatively and positively, can help you better understand if the decision to apply for one is a good fit for you.
Ways Student Loans Can Negatively Impact Credit Score
While student loans can help you build credit at an early age, they can also have a big impact on your future if they aren’t managed responsibly.
It’s likely that a random missed/late payment here or there won’t have a big impact on your credit score, but if they become a frequent occurrence, you could find yourself faced with penalty fees from your lender and a significant loss of credit score points.
Defaulting On Your Student Loan
If you stop paying your student loan for a prolonged period of time, you’re at risk of going into default, which means your account will be charged off and sent to collectors (typically after 270 days or 9 months of nonpayment). Even if your account is charged off, you’re still responsible for paying the balance.
Your Student Loan Is Sent To Collections
If your student loan gets sent to collections, it can do some serious damage to your credit score. Since payment history makes up 35% of your overall score, having a delinquent account on your record can be very damaging. All late payments, charge-offs (as mentioned above) and collections notices will remain on your report for up to 6 years, even if you manage to pay off the balance before that. The damage of being sent to collections could make it difficult for you to quality for future credit products like car loans, mortgages or credit cards. It’s worth noting that making an effort to pay off your debt will help lessen the severity of the situation and create a record of debt resolution which will help offset damage done to your credit score.
Ways Student Loans Can Positively Impact Your Credit Score
Managing your student loans responsiblycan have a very positive impact on your credit score in more than one way.
Making Payments On Time
Being timely with your payments means your lender will report your good behaviour to the credit bureaus and your credit score will grow stronger. You may want to consider setting up automatic payments from your bank accounts so you never have to worry about missing one should life (and school) get busy.
Making Monthly Payments
Since payment history makes up 35% of your credit score, making your monthly student loan payments on time is the simplest and most effective way to build up your credit and credit history. A track record of timely monthly payments will make it easier for you to qualify for other loan products in the future and could lead to lower interest rates over the course of time.
Building And Establishing Credit History
Your credit history makes up 15% of your overall credit score and this includes how many accounts you have, how long they’ve been open and how active they are. In order to calculate a credit score, credit bureaus need at least one of your accounts to be 6 months old. If you keep your student loan in good standing (full and timely monthly payments), it will help you establish a solid credit history, and as a result, boost your credit score over time.
Contributing To Your Credit Mix
Your credit mix makes up 10% of your credit score. Student loans can also help diversify your credit mix, which shows lenders that you’re capable of successfully managing different types of accounts. Typically, someone with different types of loans (like for a car, student loans and credit cards) is viewed more favourably than someone who has less of a mix (for example, four credit cards).
How New Student Loans Are Affected By Your Credit Score
There are generally two different types of loans you’ll have access to as a Canadian student. Federal loans are offered by the government while private loans are offered by financial institutions. Understanding how these two types differ when it comes to requirements and applications, will help you choose the best fit for you.
Federal Student Loan
If you have poor or no credit, federal student loans are a promising option as they don’t often require credit checks. These loans will have a fixed interest rate so having a great credit score won’t help you get access to lower rates in this case. These loans are typically approved based on your income level (or your parent’s income if you live at home) so if you make a high income, you may not qualify.
Private Student Loan
Unlike federal student loans, your approval for a private student loan is generally based on your credit score. As with other standard credit products, the better your credit score, the better your rates and terms will be with these private loans. If you have limited or no credit history, you may need to have a co-signer if you go this route. Just keep in mind that if you default on your payments, your co-signer’s credit score takes a dip along with yours.
Can Refinancing Student Loans Affect Your Credit?
While refinancing your student loan could lower your credit score in the short term, it can also have a positive impact on your credit score by helping you reduce your monthly payments, lower your interest rate or adjust the terms of your loan to work better with your personal situation.
If you’re thinking about refinancing your current student loan, know that this process will require a credit check that will lower your credit score in the short term. So, it’s wise to apply for only one or two refinancing loans in a short period of time so you can minimize the damage to your credit score. If you maintain your good standing by continuing to make payments on time and you don’t apply for any new credit cards, any damage done from the application(s) should be cleared up in a few months.
For some young adults, a student loan may be their first ever line of credit so it’s extremely important that applicants understand what student loans require and how to responsibly manage them. Student loans are no different than any other credit product in that they’ll affect the applicant’s credit score and show up on their credit report. Being timely with your payments and properly managing your loan can lead to an improved credit score over time, but mismanaging your funds can cause damage that will remain on your report for years to come and could affect your ability to secure future loan products. Take the time to learn more about your financing options and speak with a professional to ensure you find the right solution for your personal needs.