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The Relationship Between Student Loans and Your Credit Score
For a lot of people, their student loans are one of their earliest encounters with the financial world. Since lenders use credit histories to establish their would-be customers’ creditworthiness, this means that student loans are one of your first chances to establish yourself as a good borrower. Something that can make your future encounters with the financial world that much simpler and that much smoother.
How is Your Credit Score Calculated?
If you are interested in understanding how your student loans can affect your ability to borrow, you need to understand the concept of the credit score (for more information about how credit scores are calculated, watch this video here).
In brief, there is no single metric that can be used to describe your desirability as a borrower. Instead, it has to be assessed using a number of factors such as your income, your outstanding debt, and your history when it comes to making your debt payments on time. Since this is inconvenient for both borrowers and lenders, the credit score was invented to serve as a sort of summary for your desirability as a borrower. It does not take into account all of the relevant factors, but it takes into account enough of them to make it extremely useful as an estimate of your desirability as a borrower.
There are a number of systems used to calculate someone’s credit score. However, the one that sees the most use in Canada is called FICO or the Beacon Score, as it is often referred to as. Much of FICO’s popularity can be attributed to FICO’s widely understood model, which is as follows:
- 35 percent is based on the consumer’s payment history. This is based on whether individual has been making their debt payments on time. However, it is important to note that this section can also take bankruptcies, liens, and similar incidents into account.
- 30 percent is based on the consumer’s debt burden, which is an individual’s ability to manage their existing debt as well as their ability to manage further debt. Said ability is assessed using a number of debt-related metrics, with common examples ranging from the net value of outstanding debt to the number of accounts with balances.
- 15 percent is based on the length of the consumer’s credit history, which is exactly what it sounds like. This is used in assessing someone’s desirability as a borrower because a lengthier credit history makes it more reliable as a source of insight into the consumer’s behaviour when it comes to financial products.
- 10 percent is based on the variety of financial products that the consumer has been known to use. For example, someone who uses credit cards as well as instalment loans is going to score higher than someone who uses credit cards and nothing but credit cards.
- 10 percent is based on the number of “hard” credit inquiries, which is what happens when businesses look up the consumer’s credit score before making a decision to take them on as a customer or not. Too many “hard” credit inquiries is not great because it suggests that the consumer might have encountered financial difficulties.
How Do Student Loans Affect Your Credit Score?
Based on this information, it becomes clear that how well you manage your student loans will affect your chances of being approved for loans and new credit in the future. For example, if you make all of your payments on time, you are showing that you can be trusted to honour your debt obligations. In contrast, if you fail to do so, you will be charged higher interests and have to deal with harsher borrowing conditions should you need more credit in the future.
However, it is interesting to note that just the act of taking out student loans establishes you as someone that lenders might be interested in lending to. This is because having student loans means that you are building the experience you have with managing your finances.
If you are taking out student loans for the first time, you should see them as opportunities to establish your desirability as a borrower. By learning more about what your student loans entail, by honouring your debt obligations, and by making arrangements with your debtors sooner rather than latter if that proves impossible, you show yourself to be someone that can be trusted.
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