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Will student loans hurt my credit?

Eva Norlyk Smith Ph.D.

March 3, 2014

QDear Eva,

I've accumulated $60,000 in student loan debt, and I'm wondering what that will do to my chances to get a good card, new car, and eventually, a house or condo. Basically, what does student loan debt do to your credit? –Matt

AHi Matt,

The funny thing about credit is that using it wisely helps boost credit scores. As long as you keep up with the monthly payments, that student loan will help your credit score by contributing to three components of FICO scores: your payment history, the length of your credit history and your credit mix. These account for 60 percent of FICO scores, with payment history contributing the most — a full 35 percent. New credit and how much you owe are the remaining credit scoring components, comprising 10 percent and 30 percent respectively.

A student loan is considered an installment loan, while credit cards are considered revolving credit. Both count toward building your credit score. So, to get the very best credit score, keep a couple of credit cards, use them regularly, and pay them off on time and in full each month. If you keep that up over a couple of years, as well as keep on top of your student loan payments, you should have no problem building a credit score that will easily qualify you for any type of loan you need.

That's the good news. As you can tell, it's not really that hard to build great credit, once you have the basics in place: It just takes patience and persistence.  The bad news is that while an excellent credit score will qualify you for credit cards and a car loan, other considerations come into play for a mortgage.Ask Eva

The requirements to get a mortgage for a house or condo are more stringent, because more money is involved. Mortgage lenders consider numerous factors other than credit scores when evaluating a person for a mortgage. In addition to having a good credit score, you need to show evidence of a stable employment history, and have enough money saved for the down payment on the house you plan to buy (which is typically about 20 percent).

Lenders also look at your debt-to-income ratio — how much you have in debt payments each month compared to what you have coming in. The debt-to-income ratio determines whether  you are approved for a mortgage and how much of a house you can afford.

The conservative rule of thumb is that the loan payment, along with insurance and real estate taxes,  should not exceed 28 percent of your gross monthly income, and your total monthly debt (including student loans, car loans, credit cards, child support, alimony and mortgage payments) should not be higher than 36 percent of your income.

For example, if you make $50,000 before taxes a year, your mortgage, insurance, and taxes should not exceed $14,000 a year, or $1,166 a month. The total monthly debt payments (including your mortgage) should not be higher than $18,000 a year or $1,500 a month.

That means your student loan payments may lower the mortgage loan amount you qualify for. Since the student loan payments stay the same, the only way to minimize this effect is by avoiding or minimizing other loans — or, of course, paying off the balances of your student loans. Staying away from credit card debt is a no-brainer, since high credit card debt negatively affects your credit score. Adding a car loan to the mix may make things worse if your income level is border line for reaching an acceptable debt-to-income ratio.

Fortunately, you're preparing early, which makes it easier to avoid these pitfalls and ensures you take the proper steps to manage your credit effectively in order to qualify for the kind of home you want in the future. Good luck!

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