Many common student loan programs are not credit-based. Stafford and Perkins are based solely on need and don’t even do credit checks. But not all will qualify and those programs will often cover less than 100% of the needed amount, especially considering the high cost of education today.
Many students and their families will, therefore, want to supplement those with credit-based student loans. When they do, being able to show a good credit report to evaluators will result in better access to funds, with the best possible interest rate.
As with any credit-based loan, a prior history of bad credit doesn’t make getting funds impossible. But it can be much more difficult and often carries a higher interest rate.
Avoiding bad credit history can therefore be the difference between getting a loan or, if you do get one, repaying much more than you would have with good credit. But what is good or bad credit?
The first factor any loan officer will consider is the FICO score. The FICO is a number calculated by the major credit agencies based on a secret, proprietary formula. Though the exact equation isn’t public, several criteria are known, and even obvious.
FICO scores are based on outstanding debt and defaults, number of late payments and how late – 30 days, 60 days, 90 days or longer, amount of credit available, number of recent credit inquiries and other factors. All these are weighed and weighted so that, for example, a default counts very heavily, as do any late payments, with larger late days counting more. The number of recent credit inquiries counts less.
Many students won’t have a FICO score at all, not having credit cards or other forms of loan that would generate the data on which the score is based. But the majority of students are judged by the parents’ credit history, in regard to granting loans. While student credit history is important, the parents income and credit history typically count for more in making a final decision.
Both parties need to have good credit. First and foremost, that means a FICO of above 650, and the higher the better. Having a score lower than that won’t make getting a loan impossible, but it may trigger the need to supply additional information that can influence the decision. And getting that extra data into the hands of actual individuals who can be influenced is not easy.
Apart from the FICO score, and related to it, there are a number of factors that prospective borrowers should keep in mind.
Paying on time is important. Evidence of a history of late payments, incurring late payment charges is evidence of a bad credit risk in the eyes of lenders. Staying within available credit limits is important, as well. Avoiding over limit and other penalties shows a willingness to defer immediate gratification and accept responsibility. Creditors are judging not just numbers, but character as well.
Limiting the number and maximum balance amount on credit cards can also help. Excessive credit inquiries suggest to lenders that someone is having difficulty meeting current debt loads. That’s a signal that repayment of additional loans may be harder. That increases the lenders’ default rates – loans that aren’t repaid. Financial institutions will try very hard to keep that default rate low. To do that, they sometimes deny credit to borderline cases.
Meet all credit obligations and keep all borrowing to a modest level for a long period of time. That makes you look like a very good risk to loan officers, which means funding a student loan will be a slam dunk.