Student Loan Pay-Off and Credit Score

So H and I are having a disagreement. H says it’s better for S to pay off his small student loan in installments in order to establish a good credit score. S has almost no credit history now. I say it’s not worth the extra interest. He has the cash to pay off the amount in a lump sum and be done with it.

I’m asking better financial minds than mine to weigh in.

What is your son’s credit scribe now? If it’s high…I can’t see that this would matter.

IMO, if he does not need the cash as an emergency reserve, the answer is obvious: pay off the loan! He can establish credit history by getting a credit card and pay those bills every month in full without paying interest. The interest rate will likely be high, but the interest rate on the card does not matter if you pay none of it. One does not need to spend $$ to establish credit history.

If a student pays of the student loan in full, before installments come due, it will not help in any way with credit history. It doesn’t hurt – but it doesn’t help either. So the S with “almost no credit history” – remains a person with no credit history. The student loan will never be reported to the credit agencies and so will have no impact, positive or negative.

Credit scores are not determined by how much you pay in interest but the time taken to pay a loan. It’s not a good idea to pay interest just to establish a credit rating. Although it is a different type of credit and every type of credit has its own points, getting a credit card and charging a little every month and paying it off is better.

You win. Pay it off.

We really need more info - loan balance? Interest rate? Paying off the loan in monthly installments does build a credit history and raise credit score. I say this as someone who has worked in mortgage lending for 30 years. He can also deduct up to $2500 in student loan interest on his taxes. Unless the rate is extremely high, I say keep it. Establish the credit history for 12 months. Take the student loan interest deduction in 2016. Pay it off in 2017.

Just as an example, my older son has about $15,000 left on his Federal student loan at about 6%. His pymt is $166/month. He will have about $900 in interest to deduct on his taxes. His student loan and his credit card are the only two accounts on his credit report. While he has the cash to pay it off, I have advised him to keep it for now. He is better off having the stronger savings cushion and continuing to build his credit history.

He has you as an emergency backup if the sky should fall, so I’d say pay off the loan.

If he pays it off in a lump sum, does he still have a comfortable savings cushion?

He should get at least one credit card ASAP (if he doesn’t have one already) in order to have at least one account that is open long-term even if he chooses not to pay off his student loans.

FWIW I was showing my S how you can get a free credit report each year. We downloaded his and looked through it. His federal student loan showed up as an account in good standing. He’s only a freshman and won’t be making payments for a while so this surprised me. It would appear (I think) that he’s building good credit with a loan he hasn’t even started paying back yet!

I would just add that if and when a student does opt to pay of student loans over time to build a good credit score, that student should always set up an auto-pay system for the loan. You can’t build credit with missed or late payments-- so automatic payments assure that all payments are made (and recorded) on time.

Paying interest for the deduction is a bad idea. True, he gets to deduct $2500 and saves the tax on that. But he’d be far better off without the $2500 expense. He saves all of that is he doesn’t pay it.

If you have good credit, the easiest way to establish good credit for your kid is to put your kid on your credit card. Your good credit would transfer to your kid. On the other hand, if you have very high balance on the card then it may not be as beneficial to your kid.

Agreed - being an authorized user on a credit card with a perfect pymt record is beneficial.

Based on this example, we could come up with another example, by scaling up these numbers:

Just as an example, someone has about $100,000 on his Federal student loan at about 6%. His pymt is $166 • 10 * 2/3 = $3320/3, which is about $1107/month. In other words, the monthly pymt is about the 1.1% of the total loan amount.

Hmm…the missing factor here is the term of loan. Does it take 10 years to pay it back? (Somehow I have the impression that the pay back period for a Federal loan is 10 years.)

Does it make any sense to scale up the numbers in this way? Or, we need to know the original loan amount to estimate the monthly payment in this way? rockvillemom’s original example referred to the remaining amount of the loan.

This is the easiest for sure. However, if you want your kid’s credit score to increase in the fast way, should she have her own credit card and pay off the balance (which should not be high w.r.t. her limit on the card) each month? (I am not sure which way is the best way.)

As an aside, it’s not possible to take out 100k in federal student loans as an undergrad (grad school is a different story).

^ Yes. It is true. I am back in my helicoptering mode here – trying to roughly estimate the monthly student loan payment for DS in the future quickly in my head here. LOL.

Yes, Federal students loans are typically paid back over 10 years.

Being an authorized user on my card helped him establish credit, he then got his own credit card, which he does pay off monthly. Now he has his credit card plus his student loan as two accounts with excellent pymt histories on his credit report.

Pay if all off right away if possible. That’s exactly what I did within six months of graduation with the 3 figured college loan I took out so I could have a more relaxed senior year and have enough time to perform job searches/interviews.

Also, while I did have an issue of having an inadequate credit history due to not having credit cards during undergrad, getting a discovery card and using it responsibly* for a year and change was enough to get me enough credit history to get myself a bank credit card and an AMEX.

Currently have great credit scores.

  • Paying it off in full each month without carrying any balances over till next month.

In my opinion, it’s always better to have the habit of not being in debt whenever possible. Why have the weight of the student loan out there when he can be free of it? You just never know what the future holds, it’s just better to have that in the rear-view mirror.

I’m saying that with envy, my kids will be paying theirs for some time to come.