Student Debt and Improving your Credit Score
When it comes to student debt, you’re far from alone. There’s no need to stress out or feel embarrassed about your situation. Instead, gain an understanding of the options available and make things manageable.
In an episode of the AMA’s “Making the Rounds” podcast, Laurel Road’s Alex Macielak, and anesthesia fellow and AMA member Chirag Shah, MD, discussed the state of student debt in the U.S., as well as considerations for improving your credit score. Macielak works in business development for Laurel Road, an FDIC-insured bank that offers student-loan refinancing.
This is an edited transcript of the podcast.
Dr. Shah: To get an overview, what's the state of debt in the U.S. currently?
Macielak: I think it's one which is definitely growing over the last 10 to 20 years. A high propensity of Americans seem to be comfortable taking out debt, be that a credit card, a student loan, an auto loan. And there's certainly good and bad types of debt. I think where we start to see problems is people going delinquent on the debt. And about one in three Americans currently with debt are behind, or are delinquent, which is a mounting issue.
Dr. Shah: Is that student debt alone or is that encompassing all types including credit card and mortgages?
Macielak: Encompassing all types. In terms of student-loan debt, the default rate is actually a good deal lower. The federal portfolio is looking at a 10% to 15% default rate, but it's the credit cards which tend to be a big issue. People look at them less as a tool to buy things and more as a way to live beyond their means, and that's where the problems start to arise. The total amount of consumer debt has risen to $4 trillion. Student-loan debt makes up about a third of that, so $1.5 trillion in student loans outstanding. That's a number that's grown exponentially since 2005. I think the total outstanding back then was under $400 billion. We've seen a near quadrupling in student-loan debt.
Dr. Shah: Why has that been?
Macielak: I think it's primarily the rising cost of tuition. Student loans are unique in that, when you're going to take them out, there's no cap. So if a school decided they wanted to charge $80,000 next year, presumably all the students who wanted to go there just take the extra $20,000 to $30,000 in loans, whatever the tuition hike was. There's really no incentive on the part of the schools to reduce the tuition given the current format.
Dr. Shah: And then with student debt, specifically, it looks like recent college grads owe maybe about $34,000. How does that play with the medical segment? Is it more? Is it less?
Macielak: Yeah, certainly more. To put it simply, the average medical student is coming out with about $190,000 in student loans. And that's a number that's risen in line with the overall outstanding debt in the economy. Medical school tuition costs have significantly risen, and as a result people who want to go to school have no choice but to take out loans.
And I think that's something that we actually did a survey on at Laurel Road to get a sense of recent graduates' feelings towards their debt. And one of the things that surprised me most was that over half of the respondents said they felt embarrassed about their student loans after graduation, which I think is unnecessary.
There's no reason to feel embarrassed given that it's a requisite to get an education these days. Unless you had a pile of money and could pay out of pocket, or a parent that wanted to sponsor your education, you have no choice but to take on these loans. I think there’s no need to feel any type of embarrassment given the situation.
Dr. Shah: Medical school's probably a little bit of a better investment than credit card debt.
Macielak: For sure. I think credit cards are about as bad a debt as you could have given the rates and the fact that they're so dangerous. You can keep charging and charging, and you don't have to make any type of regular payment; it's a minimum of maybe $25 or $50 payment. But medical school's an investment. I would look at that kind of through the same lens as investing in real estate: You have high hopes that this money you pay to get the education is going to pay off exponentially in the future.
Dr. Shah: For me, to be honest, I looked at it as an investment. I worked prior to going to medical school, so I had a little bit of money saved up to pay for the first part of it, but obviously it's very expensive. I went to one of the most expensive medical schools in the country, and I have a lot of debt. I was able to refinance and it made me feel a little bit better about the investment I was making.
But yeah, it's a scary thought, and it's not a small number, which obviously adds to the anxiety. But as working professionals, we should be able to pay that off over the time frame that most of these loans are over. And then, specifically for Laurel Road, are the rates any different when you refinance as a medical professional versus, say, just as undergrad debt, versus maybe an MBA, or a JD what have you?
Macielak: They could be. There's several factors that we look at in under writing and pricing the loans. Degree and career are certainly some of them, as is credit profile and total monthly debt expenditures. Total monthly income as well. Those are the main things we're looking at.
Dr. Shah: And if you want an attractive rate, what are the best things you can do to position yourself before you apply for refinancing?
Macielak: I think probably the one most within your control, other than asking to get paid more money by your employer, is your credit score. That's something, at least I've found, people are maybe unfamiliar with how it's calculated and what exactly goes into it.
Dr. Shah: How is it calculated and what goes into it?
Macielak: The biggest factor is making on-time payments. That seems to be a very easy thing one would know, but you'd be surprised how many people find it perfectly acceptable to miss a month or two of paying their credit card. I think the one which people are the most unfamiliar with, which actually does play a fairly significant part in your credit score, is credit utilization level. The credit bureaus, they don't want to see you utilizing more than 30% of your revolving credit limit.
If you had a $10,000 limit on your card, they don't want to see you spending more than $3,000 a month on that card even if you pay it off every month. If you did find yourself paying more than—or using more than—30% of your revolving credit limit each month, you would want to call the credit card company to ask for an extension on your line of credit, and that'll reduce your credit utilization level. That's one pretty significant opportunity to increase your credit score through really doing nothing other than calling the credit card company.
Dr. Shah: Right. And then a lot of people also worry about applying for new credit cards. Does that hurt your score, or will it help overall since your total credit line will increase with whatever you're approved for?
Macielak: Yeah that's a good question, and I think there are some nuances to it. As you said, taking out another card increases your overall revolving credit limit, which should help. Another factor though in your credit score is how seasoned are your accounts? How old are they? If you have a lot of new accounts, that won't reflect particularly well on the credit score.
What I've recommended in the past for people to take a look at is if you have a card—say that you took out in high school or college and has no annual fee—even if the benefits of the card really aren't that attractive later in life, just keep it open because that card will stand as a long-standing credit account that you've had open, and that'll help improve the score.
Dr. Shah: OK. It sounds like the five components we've kind of gone over for the FICO score are the payment history, the amount owed, the length of credit history, new credit and the types of credit used. So then how do I protect my credit score once I get it to the level I want it to be at? How do I avoid identify theft, and what kind of precaution do you recommend one takes?
Macielak: I think being vigilant in checking your credit score at least once annually. There are a number of services which can provide you an automated update at much greater frequency than that, but continuing to monitor it is the biggest thing. Identify theft can go unnoticed for months if you're not on top of your credit score and continually checking it.
Dr. Shah: What exactly is a good FICO score? I know the range is wide. What would you recommend?
Macielak: It is a wide range from 300 to 850. Though, anecdotally, I have seen no credit scores in the 300s and very few in the 800s as well. The scores, by and large, are pretty concentrated in … call it the 600 to 750 range. In terms of refinancing with Laurel Road, our credit score minimum is 660. That's similar to what it would take to qualify for a mortgage. Mortgage requirements on a conventional mortgage might be a bit lower than that, but by and large, you want to have a credit score of at least 650.
Dr. Shah: Does it matter if your score is higher? Will you get a lower interest rate or, if it's lower, will you get a higher interest rate?
Macielak: Both. The higher your credit score is, the more favorable pricing and terms you'll receive on loan offers. Not just student loans, but mortgages, auto loans and credit cards. The higher your score, the more favorable terms you're going to qualify for. And conversely, the lower your score, the less options you'll have at your disposal. I mean, on the credit cards side, if your credit was really suffering and subprime, you would have a hard time qualifying for some of those premier type of cards with nice point incentives that we talked about. You're more likely in a starter, credit-building type of card.
Dr. Shah: If my score was struggling, and it was 500, I should reduce the amount of debt I owe, get current on missed payments and then pay off debts that have gone into collection. And I guess I can always increase my credit limit by applying for more cards, but that's something to be exceptionally careful with, especially if you're struggling with repayment. … Otherwise it's a spiral, and your scores obviously won't improve if you're utilizing that new limit.
Macielak: Correct. I know that it's a tough situation if you've had some struggles with your credit, but there are certainly steps which you just outlined that can be taken to increase a credit score. And I think, holistically, credit scores tend to increase organically as you progress through your career.
To hear the full Making the Rounds podcast and to see the variety of career planning podcasts available through the American Medical Association go to the podcast page.
The AMA’s Career Planning Resource features a primer on medical student loans that explains the basics of loan interest, grace periods, deferment and forbearance, and delinquency and default. It also features links to loan-repayment assistance and scholarship programs.
AMA members who refinance their student loans with Laurel Road receive an additional 0.25% rate discount through AMA Member Benefits PLUS