College loans don’t have to be an albatross around your neck. If you’re in school or have graduated, these three tips will help make college loans a benefit rather than a disaster for you.
A student loan is usually the first opportunity to borrow money from someone other than a family member. Many student borrowers manage loans well and build a foundation for very positive credit score – an important number calculated by one of three credit rating bureaus based on how well you manage your credit. You want a high score so credit card companies and banks will lend you the money you’ll need for a house, a car and living expenses.
Here’s what you need to know about credit scoring:
There are three major credit bureaus:
Equifax, TransUnion, and Experian. Each has a model similar to one first created by Fair, Isaac and Company (FICO) to help lenders systematically gauge a borrower’s capacity and propensity to repay financial obligations.
Credit scorecards differ slightly but generally judge these characteristics:
- Payment history (35%) – do you pay on time?
- Debt Burden (30%) – how much do you owe compared to available credit and number of accounts with balances?
- Length of Credit History (15%) – how long have you had credit?
- New credit in the past 12 months (10%)
- Mix of Credit (10%). Do you have credit cards, loans, retail accounts?
You can get a FREE copy of your credit report annually from each of the credit bureaus at www.AnnualCreditReport.com. It’s a great idea to do that!
As you gain experience paying bills (rent, utilities, etc.) and debts (student loans, car loans, etc.), your credit score will change. It will increase when you do good things (i.e. pay on time) and lower if you make mistakes (i.e. miss payments).
If you find yourself with a low credit score, you can recover but it takes time and discipline to repair bad credit. Your best bet: avoid the trouble in the first place.
Here are three tips to ensure that student loans help you establish good credit:
Be a smart borrower.
If you are entering, or are in, college, borrow as little as possible now to cut down on the payments you’ll need to make later. One rule of thumb: don’t borrow more than what you’ll likely earn in your first job.
Also, try to pay interest on the loans while you’re in school. The monthly interest amounts should be pretty low.
If you don’t pay the interest each month, your lender will add it to your loan balance. The result will be a larger loan payment after you leave school – at a time when you’ll need money for rent and food.
Always pay your loans on time.
35% of your credit score depends on your payment history so paying on time is key. If you get into trouble, call your student loan servicer sooner rather than later. You may qualify for a government program to help make student loans more affordable.
Millions of borrowers use the ”Pay As You Earn” program that allows maximum monthly payments of only 10% of your discretionary income and stretches the time you have to repay from 10 to 20 years.
Others use the Income-Based Repayment program capping monthly payments at 15% of discretionary income. There are pros and cons for each of the government’s programs.
Do some research and take advantage of one that will help you pay down your loan as quickly as possible but with monthly payments that are manageable.
Know your options to consolidate or refinance your college loans.
If you are out of college and have more than one federal student loan, you may consolidate those loans into one loan.
You won’t save on the interest cost because the new interest rate will generally be the weighted average of the interest rates on the underlying loans. But the term of the loan may be extended thereby reducing your monthly payment.
The downside is that you will pay more total interest over the life of the loan. If you have private student loans and a good credit score, you may be able to save money by refinancing higher interest rate to lower interest rate loans.
You may also refinance your federal loans into a private credit loan but you will forgo the federal benefits, which may include loan forgiveness options.
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Your student loan can help you establish a track record of success as a borrower, leading to future opportunities to borrow money at lower interest rates.
If you found this helpful, check out our book, which talks about all of this in more detail.
John A. Hupalo is the Co-author of Plan and Finance Your Family’s College Dreams and the Founder of Invite Education (www.Inviteeducation.com). Check out the blog at: https://b2b.inviteeducation.com
