How does the lender set my interest rate and origination fee when I request a private student loan? Many lenders set the pricing of private student loans based primarily on the likelihood that the borrower (and any cosigner) will repay the loan on time. Applicants who are more likely to repay their loans on time often receive lower interest rates and lower fees, such as the origination fee. To predict creditworthiness, lenders use statistical programs called credit scoring systems or models. The main way that most lenders, including private student loan lenders, determine your likelihood to repay your loan or your creditworthiness is by analyzing your credit or FICO score.
In most cases, when you ask to be pre-approved for a loan, or when you apply for a loan, you are authorizing the lender to obtain your credit report from a credit agency. This report typically includes your credit score. The lender applies a credit scoring model to your credit report information and credit score to set the pricing of your loan. What is a credit scoring model and how does it calculate my credit score? Credit scoring models are important because generally they make the credit granting process fast, efficient and impartial. To build a credit scoring model, the developer may review data from millions of credit reports and will strive to identify the factors that best predict who will repay debt. Most of these models include the following factors, among others:
- Whether you have a history of paying your bills on time,
- The number and type of accounts you have,
- The amount of your outstanding debt, and
- The amount of unused credit on your credit card accounts.
Points are assigned to each factor based on how strongly it predicts creditworthiness. Your credit score is the sum of these factors when applied to the information in your credit report. Scores are fluid numbers that change as the elements in your credit report change. For example, payment updates or a new account could cause your score to change.
Under the Equal Credit Opportunity Act (ECOA) and many state laws, a credit scoring model cannot use as factors certain characteristics, such as race, gender, martial status, national origin, or religion. How can I protect and improve my credit score? Especially if you are young or have a short credit history, it is important be careful how you use your credit. Below are tips to protect and improve your credit score.
- Are you paying your bills on time? This is the most important thing you can do to protect your credit score. Fair Isaac, Inc. (the company that designs the FICO score which is most commonly used by lenders) says payment history is 35% of a credit score.
- Have you maxed out on your lines of credit? Many scoring systems compare your outstanding balance on an account to your credit limit. If the amount outstanding is close to your credit limit, it may have a negative impact on your score. Two credit cards, each with a balance that is only half of the credit line, are better than a single card that is fully extended.
- How long have you had credit? Length of credit history accounts for 15% of a score, according to Fair Isaac. Older accounts are more helpful to your score, so if you want to close accounts, consider closing the newer ones.
- Have you applied for new credit recently? If you have applied for too many new accounts recently, it could have a negative effect on your score. New credit constitutes 10% of a FICO score, and an inquiry can be part of the score for 12 months.
- Have you opened any more credit accounts than you actually need? Too many credit card accounts may have a negative effect on your score.
- Do you use your full legal name in bank accounts, credit applications and other documents that could contribute to your credit history? Credit bureaus obtain information from a variety of sources. If you are consistent in the use of your name, it is less likely that information from a person with another (or similar) name could end up on your credit report.
- Do you notify your current or potential creditors before you move? If you change your name, do you notify them as well? If you move and don't notify your credit card issuer, you could miss a statement and then have to make a late payment. When the card issuer reports that tardiness to the credit bureau, it could reduce your credit score.
It is also important to know what is in your credit report. Each year you can get a free report from one or all of the three national credit bureaus. Visit www.annualcreditreport.com or call toll-free 1.877.322.8228. How do I shop for a private loan?
Before you shop
Before shopping for a private student loan, determine the amount of credit you really need.
- Make a budget and find out the expected cost of attendance at your school. Don't get more credit than you actually need to cover reasonable educational expenses.
- Be sure to exhaust the free and cheap money (e.g., scholarships, grants, work-study, federal aid and federal loans) before you consider a private loan.
- If you use a private loan to pay the Expected Family Contribution ("EFC") computed in connection with federal aid, and if you borrow more than the EFC, the excess could reduce the amount of your federal aid.
Where to shop
You can shop for a private loan by contacting the lenders recommended by your school, contacting your bank, and surfing the web.
Many lenders will provide you a pre-approval for a loan that is good for a limited period of time and that includes pricing, based on your credit history. Some websites will help you compare general loan product features, although typically you cannot obtain your actual interest rate on a possible loan until you submit a pre-approval request or apply for a loan.
Loan features to compare
When you are comparing various private loans, ask the following questions:
- What is the Annual Percentage Rate ("APR")?
- If the APR is variable, what index is it based on? What is the maximum rate that could apply to the loan?
- What origination, disbursement and other fees could apply?
- What borrower benefits are available that could reduce the amount I would need to repay?
- What is the late fee?
- Can I defer payments while in school? (If you are able to pay at least interest while you are in school that will reduce the overall cost of your loan.)
- If I defer any payments while in school, how long is the grace period before I must start making payments of principal and interest?
- Does the loan offer an income-sensitive repayment option that would adjust as my income changes?
- What deferments or forbearance options are available? For example, if after I graduate I decide to pursue further education or join the military, could I defer payments?