Student loans affect debt-to-income ratios, credit scores and more — how to protect yourself

Millions of Americans feel the stress of student loans. According to the Office of Federal Student Aid, more than 45 million people have federal student loans, accounting for over $1.5 trillion in total debt owed.

These debts, while manageable for some, have the ability to wreak havoc on the financial lives of others. They hurt debt-to-income ratios, lower credit scores, and make it harder to invest, save, and even prepare for emergencies. They can also put goals like buying a car or house out of reach as well.

If you have student loans, it’s important to be diligent in how you manage and repay them — especially if you want to safeguard your financial health.

How student loans affect your finances

Student loan debt can put a strain on anyone’s personal finances — both current ones and those down the road. Specifically, they can impact your:

Credit score

When you take out a student loan (or any loan, for that matter), it shows up on your credit report. Your payments do, too, and they have the power to send your score up or down, depending on how you manage your loan.

HOW STUDENT LOANS AFFECT YOUR CREDIT SCORE

Late payments are particularly detrimental to your credit score, according to Rick Castellano, a spokesperson at student loan company Sallie Mae. “Loans become delinquent after you miss your payment due date. Late payments may be reported to consumer reporting agencies, which can impact your credit score.”

On-time payments (especially over a long period of time) can do the opposite, actually improving your score.

Debt-to-income ratio

The higher your loan balances are, the higher your debt-to-income (DTI) ratio goes (the portion of your monthly income that goes towards debt repayment). DTI plays a role in what financial products you can qualify for, including credit cards, loans, and even mortgages. A high DTI can significantly limit your financial options.

Your savings efforts

It can be difficult to save for retirement when all your funds are going toward your student loans. Those balances can also impact your ability to invest and build wealth for the future, and they could even make it hard to build up an emergency savings account. According to a recent study from JPMorgan Chase, the average family needs at least six weeks of take-home pay saved up to weather an income change or other emergency. Nearly two-thirds of households don’t currently have this.

How to stop student loans from derailing your life

Letting your student loans fall into default is probably the worst thing you can do for your financial health. Not only does it mean paying more in interest (plus potential collections fees), but you also may see money taken straight from your paycheck or have your tax refund withheld until the balance is repaid.

WHAT IS THE 2+2 PROGRAM TO REDUCE STUDENT LOAN DEBT?

Here are some steps you should take to protect your financial health (and keep those loans in check while you do):

1. Consider an income-based repayment plan. These plans base your monthly student loan payment on your income level, making payments more manageable and helping you avoid late payments (which could hurt your credit score or lead to default). They also free up more cash so you can save, invest, and keep your head above water.
2. Think about refinancing your loans. This could qualify you for a lower interest rate and, thus, a lower payment. Use the saved funds to put toward your emergency savings fund, retirement, or to achieve a major financial goal, like buying a house or a car.
3. Know where your focus is. While it might be tempting to make large payments to pay down your student loans as quickly as possible, it’s not always the most beneficial move for your wealth. In some cases, it may be better to invest than to pay off those loans faster. Do a full comparison to see where you should focus.
4. Set up autopay. If you have private student loans, many lenders will give you a discount on your interest rate just for setting up autopayments. If you’re able to score this perk, put the cash you save toward that homebuying fund or emergency savings account.
5. Shop around for your savings accounts. Don’t just choose the first savings account you find. Compare banks and credit unions, and make sure you’re getting the highest interest rate possible. This will maximize how much you accumulate over time — even if you can only stow away a minimal amount of cash.

You might also consider consulting a financial planner for more personalized advice, and Castellano recommends reviewing your credit report regularly to check on your financial health. “A user is allowed three free credit reports annually. On these reports, you can see all your loans and debt, whether they are federal student loans, private student loans, or both. This is a good time to not only check on the status of the loans, but to make sure everything on the credit report is accurate.”

How to minimize student loan debt

Minimizing the number of student loans you take out is the best way to safeguard your credit and your personal finances. Consider grants and scholarships before dipping into the loan pool, and always call your lender before skipping a payment or letting your loans fall into default. The long-term costs of these slip-ups can be significant.