Planning to apply for student loans? You might want to check your credit.
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If you're applying for a federal parent PLUS loan, a student PLUS loan to pay for graduate school or if you need private student loans to cover a funding gap, your credit history will come into play. And that can create problems for some students.
"I've been hearing about a lot of people in their teens and 20s who don't have credit cards because they don't want to pay interest," says Liz Weston, a personal finance columnist for MSN Money and author of "Your Credit Score." "That can mean they don't even have a credit score. It's tough to get a private loan if you don't have a credit score."
Fortunately, the most common types of federal loans to pay for undergraduate education -- Stafford and Perkins loans -- don't require a credit check. Experts say those should be your first choice because they offer lower long-term interest rates, better repayment terms and more protections for borrowers.
How federal PLUS loans use your credit score
Federal PLUS loans, available to parents of undergraduates and to graduate students, also offer protections for borrowers.
However, the government will check your credit to determine your eligibility, says Isaac Bowers, senior program manager of educational debt relief and outreach at Equal Justice Works, a Washington, D.C.-based nonprofit. You will be denied if you have what the government calls an "adverse credit history," which it defines as being more than 90 days late on any debt, or having debt within the past five years subjected to default determination, bankruptcy discharge, foreclosure, repossession, tax lien or wage garnishment.
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Your numerical credit score isn't a factor, Bowers notes, so you can get PLUS loans even if you have an iffy credit score. And if you do have an "adverse credit history" under the government definition, you can recruit a creditworthy "endorser" or a co-signer and still get the loan. But think carefully about that, Bowers warns, "because that person will be on the hook for your loan."
How private student loans use your credit score
While federal loans typically have more favorable terms, they don't always provide enough money to cover the spiraling costs of college, so some students have to turn to private student loans to cover the gap. The Project on Student Debt, a Washington, D.C.-based nonprofit, estimates that about 14 percent of undergraduate borrowers carry private student loans. Private lenders do use your credit score and your credit history to determine your eligibility for their loans, and they typically offer higher interest rates and less favorable borrowing terms to those with lower credit scores.
You need a score in the 800s to get the best possible rates on a private student loan, says financial aid expert Mark Kantrowitz, senior vice president at Edvisors.com, which publishes more than a dozen websites about planning and paying for college. "And if you have a score under 620, it's almost impossible to get one." Private loans may tempt students with interest rates that start as low as 3.4 percent, but those are variable rates that can spike over the length of the loan. For those with poor credit, rates can be as high as 18 percent. Private lenders may also consider adverse events in your credit history, your earning potential and your debt-to-income ratio, Kantrowitz says, when deciding whether to approve your loan request. If they have concerns, they, too, may require you to get a co-signer. In that case, they base eligibility and the interest rate on the credit score of your co-signer.
Build and repair your credit before you apply
Remember, federal loans are the best option and offer the best terms, so you should always start there. But if you think you're going to need other types of loans in the near future, it's a good idea to take action now to build or repair your credit. Experts recommend the following steps:
- Check your credit. At least six months before you apply for any loans, request a copy of your credit report from the three reporting agencies through AnnualCreditReport.com (available free once a year from each credit bureau). Dispute any errors you find. If you want to know your actual FICO score (a good idea), go to myFICO.com, pay the $19.95 fee, and request it from the three agencies.
- Consider a secured credit card. If you don't already have one, apply for a credit card to start building your credit history. If you don't qualify because you have no history or have a poor history, Weston recommends a secured card, in which you give the bank a deposit that becomes the credit line for the account.
- Pay your bills on time every time. Your bill payment history comprises 35 percent of your FICO credit score, so sign up for automated payments, email payment reminders or whatever it takes to make sure you don't miss a payment, says Anthony Sprauve, spokesman for myFICO.com, the consumer education division of FICO.
- Stay away from your limit. For the best credit score, keep all of your debt to less than 20 percent of your total available credit, Sprauve says, and also try to keep each card's debt to less than 20 percent of the card's limit. When paying off card debt, focus on the card in which you're closest to the limit. "The credit-scoring formula is incredibly sensitive to how much of your available credit you're using," Weston says. "If you charge a lot on one card and get close to your credit limit each month, even if you pay it off in full, you may be better off getting another card (and increasing your available credit) and distributing your purchases between them."
- Become an authorized user. If a parent or another relative of yours has a great credit history, ask if you can be added as an authorized user. Some card issuers have a policy of exporting historical data from one cardholder to the files of all authorized users on the account, which can boost your credit score as well. "Some issuers will only do it for spouses; others do it for anyone," Weston says. "If you want to make sure it will help, have your parent call and ask first."
Remember, if you've maxed out your federal financial aid and you're having trouble getting a private student loan, it may be a sign that you're spending more than you should. "In many cases, if you can't get that private student loan, that means you need to switch to a less expensive school or economize in other ways," Kantrowitz says. "Your total debt at graduation should be less than your annual starting salary once you graduate. If it exceeds that, you're going to struggle to pay."