First the good news: Bad credit isn’t a death knell for student loan applicants, since most undergraduate loan money comes from the federal government and the feds don’t use credit scores to approve applicants.
That means that even if your FICO credit score has fallen below the acceptable range for most forms of borrowing, you still qualify for federal student loans.
Unfortunately, for some students, they need more to pay for a college education. In that case, there are private loans, mostly from banks and credit unions. Experts advise you to exhaust all possibilities for federal loans before considering private student loans.
The reasons are compelling: cost and qualifications. Private loans cost more because of higher interest rates and fees they charge. Also, before you can qualify for a private loan, the lender likely will do a credit check. If you have bad credit already, it might be tough to qualify.
Student Loan Options
The federal student loan awards don’t depend on a borrower’s credit score, but come with borrowing limits. Apply for federal financial aid by completing the FAFSA, the Free Application for Federal Student Aid. The results will tell you if you qualify for loans from the William D. Ford Federal Direct Loan Program that includes Direct Subsidized Loans, Direct Unsubsidized Loans, Direct PLUS Loans and Direct Consolidation Loans. Those four programs account for 80% of the federal loans made for college students.
In most circumstances, students and their parents can develop a funding package that includes federal loans, scholarships and work-study options that will meet their financial needs. But federal loans come with limits.
Most student loans have three types of limits:
- An annual maximum linked to the student’s year in school. The limit for dependent children (those still claimed by their parents for tax purposes) starts at $5,500 for freshman year, increases to $6,500 as a sophomore, then maxes out at $7,500 for every year beyond that.
- An aggregate limit, which puts a cap on the total amount that can be borrowed during a student’s academic career. In the 2015-2016 academic year, the limit for a direct unsubsidized loan to a student financially dependent on another was $31,000 for an undergraduate degree.
- A cost of attendance limit. This principle says a loan must be less than the school’s cost for a student’s attendance minus whatever scholarship money is provided.
Borrowing limits for students who aren’t declared dependents of another person have higher aggregate borrowing limit starting at $9,500 and increasing to $10,500 the second year and maxing out at $10,500 for every year beyond that. Those higher limits also apply to students whose parents don’t meet certain financial criteria.
Federal loans are both subsidized and unsubsidized. The subsidized portion of the loan doesn’t require interest payments until graduation, since the government pays the interest while the student is enrolled. The unsubsidized portion accrues interest during the borrowing period which must be repaid after graduation.
Undergraduate vs. Graduate Student Loans
If you need student loans to attend graduate school and already received loans to get your undergraduate degree, you are slightly ahead in understanding the game, but only slightly.
There are some significant differences in the application process for federal graduate student loans.
Here are a few worth noting.
- The Department of Education conducts a credit check during the application process and if it reveals an adverse credit history, it could end up in you being denied a federal loan.
- The federal loan programs available for graduate students are Direct Unsubsidized Loans and the Direct PLUS loan. Students can borrow up to $20,5000 from the Direct Unsubsidized Loan program. The Direct PLUS program allows students to borrow the cost of attendance minus any other financial aid received. The cost of attendance is determined by the school.
- If you have bad credit and need a graduate student loan, finding someone with good credit and having them agree to co-sign the loan with you will help your cause.
- If there are extenuating circumstances surrounding your credit history, and you have documented proof of that, you could have your case reviewed. It’s up to the discretion of the DOE to determine whether you qualify for a loan.
- If you use a co-signer or submit a request to declare extenuating circumstances, you must agree to take credit counseling.
- If you apply for private loans, the same provisions – finding a co-signer with good credit, submitting proof of extenuating circumstances – will help your loan application. Also, some private lenders don’t make decisions based strictly on your FICO credit score.
Alternative Funding Strategies
Students who need still more money might consider “peer-to-peer” borrowing through websites that link them to anonymous lenders. You may be able to work out better loan terms that suit your needs with a private investor. The people offering the loans are doing so to help out students in need. Be aware that this type of a loan can be risky, as it is not as secure as a loan from the government or a commercial bank.
Students might also consider asking people they know for a personal loan. Friends and family members might lend you at least some of what you need. The terms can be more flexible, and the lender will usually be willing to work with you because he or she knows you. Even in these cases, however, draft a contract detailing the agreement and repayment terms.
Am I Eligible for Privately Funded Student Loans?
Most private lenders use your FICO credit score to determine if you qualify for a loan. Your score tells lenders how likely you are to repay your loan: the higher your score, the easier it is for you to borrow money with good terms, including lower interest rates and longer repayment schedules.
Like federal loans, private loans also typically have limits, with most putting an aggregate borrowing maximum of $75,000 to $120,000 for undergraduate students. The limit is the total allowable federal and private student loan debt permitted.
Many students can’t qualify for private loans because they don’t have credit histories. The most common solution for this is to find cosigner. A cosigner agrees to pay your loan if you fail to make timely or regular payments. This can be a parent, family member or friend with good credit to cosign. This might not be so easy, since the cosigner will be liable to repay your loan if you can’t, or won’t, do it yourself.
The alternative there is to build your own credit history – or repair the one you already started – before taking out student loans. Credit cards are usually the starting point for this option.
Special Loan Programs
Students from low-income backgrounds studying toward degrees in the health sciences and teaching might be eligible for special financial aid through federal Department of Health and Human Services programs.
Some of the choices include:
- Loans for Disadvantaged Students and Health Professions Student Loans programs, which offer low-interest, non-credit loans to socially and financially disadvantaged students studying toward some health-science degrees. Osteopathic medicine, allopathic medicine, dentistry, veterinary medicine, pharmacy and optometry are among the specialties that fall under the program. HHS also funds scholarships for students from disadvantaged backgrounds studying toward a health-sciences degree. Students must apply for loans through their college’s or university’s student aid office.
- Nursing Student Loans funds long-term, low-interest loans to needy students enrolled in full-time or part-time dentistry, optometry, pharmacy, podiatric or veterinary medicine programs. Funding is available to schools participating in the program. Check with your financial aid office.
- Nurse Faculty Loan Program. This program funds participating schools to assist nurses enrolled in graduate studies to become qualified nurse faculty members. The program offers partial loan forgiveness of up to 85% over four years to students who graduate and become full-time faculty members at accredited nursing schools.
- Health Professions Student Loans, which provides grants to participating schools to make long-term, low-interest loans to full- and part-time students in dentistry, optometry, pharmacy and podiatric and veterinary medicine.
- Primary Care Loans is a program that funds long-term, low-interest loans for full-time, needy students to study toward degrees in allopathic and osteopathic medicine. Loans for third- and fourth-year students may be increased to repay outstanding balances accrued on other loans taken out earlier while studying at the same school. Students must agree to enter residency training within four years of graduation and practice in primary care while repaying the loan.
Can I Improve My Credit Score?
If you don’t need a private loan immediately and can delay applying for a loan by a few months, you can improve your credit score and make yourself a better borrowing candidate. The first thing you should do is request copies of your credit reports. You can request a free copy from Experian, Equifax or TransUnion, once every 12 months. Review them and dispute any errors. Surveys say that more than 20% of credit reports have errors in them. Once the mistakes are erased, you’ll see an immediate improvement in your score.
Reducing total debt levels and having consecutive months of on-time payments will also boost your score. Work on this for several months to further improve your score.
If you have no credit history at all, it’s still a good idea to check your credit reports. Then you can start building good credit by applying for your own line of credit, such as a department store credit card. Or you may want to ask to be added to someone else’s account. If someone you know has a line of credit with a good history, you may be able to inherit the positive history by being added to the account.
Overall, having bad credit probably won’t affect your opportunities to receive financial aid for college, but it’s a good idea to work to improve your score anyway.
Student Loans Affect Credit Score
School loans impact your credit score in ways that might surprise you.
Paying off a loan early might weaken your credit score. Education loans are repaid in installments, and making payments on time helps demonstrate you’re a reliable borrower. If you pay off the loan early and no longer have installment debt, you lose evidence of being an on-time payer, and that could lower your score.
Not paying on time will damage your score. If you are having trouble making payments, ask for a deferral or forbearance, neither of which will hurt your credit score. When you bring your account up to date, it will improve your score. Remember, student loans aren’t dischargeable debt. Even if you file for bankruptcy, it’s extremely unlikely your student loans will be excused, so not repaying is almost never an option.
You could raise your score by making interest payments on student loans while still in school. Also, you have a six-month grace period after graduating to begin making payments, but if you start earlier, that can have a positive impact on your score.
The most critical factor with college loans is to make certain you don’t default. This can ruin your credit score and stay on your report for seven years.
It makes sense to ask for a free credit report every year to make sure your payment history for education loans is being reported accurately.