Credit History Matters More Than You Think When Applying for a Private Education Loan

Pursuing a private education loan to finance your educational goals requires careful research. Whereas federal student loans require a completed FAFSA form, entrance counseling, and a valid master promissory note, private education loans involve an application process to determine your creditworthiness. This application process runs a credit check. Young borrowers without a sufficient credit history will need to find a co-signer, a difficult task in some circumstances.

Private education loan services, such as Sallie Mae or College Ave, use your credit history to establish three baselines before they decide to loan you funds to finance an education. Those three baselines are: your credit profile, which indicates your risk as a loan borrower; your overall eligibility for a private education loan product; and the appropriate interest rate to charge you on the loan.

The federal government primarily finances federal student loans. In addition, the only requirements to receive a federal student loan are completing the FAFSA and meeting the eligibility requirements set by the Education Department. Standard federal student loans do not require a review of your credit history. The only exception to this stipulation is when your previous federal student loans are in default.

Qualified financial institutions, such as banks or credit unions, primarily finance private education loans. Their risk profile is much different than the federal government’s. Whereas the federal government can garnish your wages or tax refunds to collect on defaulted federal student loan obligations, private lenders do not always have the same recourse. Therefore, private lenders require a credit history for each applicant to assess the borrower’s creditworthiness. This research protects the financial institution from making dubious loans to unworthy borrowers.

Why does a healthy credit score and history matter to obtaining a private education loan? Well, for starters, lenders need to create a risk profile of you as a borrower. This assessment looks at your prior credit history to determine your faithfulness in repaying loan products on time. It also highlights your overall maturity as a borrower.

After reviewing your risk profile and establishing an assessment of your credit history overall, lenders then begin the process of approving you for an educational loan. Some lenders enforce strict minimum credit scores before the underwriting process commences. The higher your FICO score (or any other comparable credit score measuring tool), the better your odds are at obtaining an educational loan. Weaker scores may signal to the lender that you are not creditworthy. In those cases, you may need to find a co-signer with a strong credit history to buoy your weaknesses in credit.

Borrowers with strong, healthy credit scores are more likely to obtain an educational loan with a lower interest rate. Like any other loan product, higher credit scores improve your odds of receiving favorable financing. Younger students, especially undergraduates, are unlikely to have an established credit history when they apply for an educational loan. When building a credit history at a young age, students need to understand that their actions today can positively or negatively affect future loan access at higher levels of education, such as graduate or doctoral levels.

Maintaining mature debt levels as your income grows is equally important. Lenders often review your debt-to-income ratio to see what existing debt you have in your name. Too much existing debt poses a risk to a lender because the new debt from the education loan could be too risky for repayment if the borrower’s income gyrates to lower levels. Paying off high-interest debt, such as credit cards, is a savvy financial move to improve your odds of receiving a private education loan.

If your credit score or history is unsatisfactory, a lender will require a co-signer before approving your loan application. Co-signers should know the following before committing to a student’s education loan:

• Co-signers are responsible for repaying the loan if the principal borrower defaults.
• Co-signers should be aware of the education loan’s terms and conditions, often referred to as the loan’s covenant.
• Co-signers are increasing their debt-to-income ratio when co-signing an education loan. That action can have adverse consequences if their income changes or if they need to obtain other forms of financing (e.g., a car note, a mortgage).
• Co-signers have an invested interest in the student’s education. Students and their co-signers need to reach an agreement on best practices for sharing information about the student’s academic performance and tuition billing.

Credit history matters a lot when deciding on a private education loan to finance your remaining costs. Undergraduate students are more susceptible to needing a co-signer than graduate students due to their limited credit history. As undergraduate students build a credit history, they must repay their debts in a timely, responsible manner. A failure to do so can jeopardize their ability to obtain private education loans in graduate school or result in higher interest rates if their prior credit history is circumspect. Co-signers have an obligation to understand the loan’s terms and conditions before co-signing, and more importantly, have a frank conversation with the student before investing in their education.

Building a mature credit score and history is much like building Rome: it takes more than one day. But starting a healthy relationship with credit today can make those hurdles less of a barrier in the future, when financing your education becomes paramount.