How student loans can be a better credit builder than credit cards

This post originally appeared February 5, 2015, on as “How to build credit with a student loan

By Barry Paperno

Dear Speaking of Credit,
How long do government-insured student loans get reported to the credit bureaus? If you are current, do they show up and help your credit score or only get reported when they are delinquent?  — Ron

Dear Ron,
To answer your questions:

  1. All student loans will appear on your credit report from the time the loan originates — even when initially deferred — until about seven to 10 years after being paid in full, regardless of how many years that might take.
  2. All student loans are reported to the credit bureaus monthly whether current or delinquent, with late payments remaining for seven years.

This subject of how student loans appear on credit reports got me thinking about how there are not a lot of good things being said about student loans these days, perhaps rightfully so. While federal student loans provide for some repayment flexibility for borrowers in financial straits, once in default, garnishment of wages, tax refunds and even Social Security payments are often the consequences. And other than in rare cases, student loans cannot be discharged in bankruptcy, giving them the distinction of being one of the very few debts a distressed borrower can never climb out from under.

Yet there’s a brighter side. A student loan can be the financial difference between achieving and not achieving a college degree for students who would not otherwise be able to afford college and who either don’t have a credit score or don’t have a “good” credit score. For these young people, there is another positive side to student loans: They can build or rebuild a credit score.

Building credit means creating a solid FICO credit score, which only requires that a credit report show one credit account (collections and public records don’t qualify) that was opened at least six months ago and one account last reported to the credit bureau within the past six months. This minimum scoring requirement can be met by a single account or two accounts, with each meeting at least one of the two criteria.

When the subject of building or rebuilding credit arises, I often recommend secured and authorized user credit cards, as they are easy to qualify for and when managed properly are all that’s needed to establish a good credit score. But often overlooked in these discussions is the credit building that takes place for millions of young people through their student loans.

For establishing credit on your own, without Mom’s or Dad’s help, federal student loans and secured credit cards are about the only credit products available to people with no prior credit history. Although when it comes to their impacts on credit scores, these two kinds of credit are at the same time very similar and vastly different in their potential impacts to a credit score.

The similarities mostly lie within the scoring calculations that evaluate payment history and the length of time credit has been established. For example, a late payment will have about the same effect on your score whether it’s for a student loan, auto loan or credit card (secured or unsecured). A student loan will contribute as positively to length of credit history calculations, such as “average age of accounts,” as a mortgage of the same age.

Where a huge difference occurs between student loans and secured cards is within the credit scoring category that considers how much you owe. Here, a high credit card balance in relation to the card’s credit limit (credit utilization) can do much more damage to your score than a student loan balance many times higher.

For consumers with student loans being repaid on time each month or still in deferment, this should be welcome news, especially for those who prefer debit cards, prepaid cards or good old-fashioned cash to credit cards. With a student loan on your credit report, there’s no need to carry a credit card solely for the purpose of establishing credit.

Still, I would not recommend taking out anything more than a small student loan solely for the purpose of building or rebuilding credit, as the interest expense over many years could be steep and the lack of flexibility should you experience financial difficulty could make matters worse. Instead, using and paying off a secured card each month or being added as an authorized user to a family member’s or friend’s credit card in good standing makes much better sense.

Have a question or comment?  Let’s hear it!

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