If you're considering refinancing student loan debt or taking out private student loans to pay for school, your credit score is important.
When you're borrowing federal direct student loans as an undergraduate, your credit score doesn't matter. But if you need to take out private student loans — something about 14% of undergraduates do — the lender will consider your credit history and credit score as part of the application.
Lenders will also review your credit if, after you graduate, you apply to refinance some of your student debt, a move that bundles one or more of your federal or private loans into one new private loan with a single interest rate.
You'll need a credit score of at least 750 to get the best rate on a private student loan, says Betsy Mayotte, president of The Institute of Student Loan Advisors. That rate is currently about 2.5%. You may still be able to qualify for a loan with a score as low as 650, but your interest rate will be much higher — in the range of 8% or 9%, she says. Some private student loan providers charge rates as high as 14%.
The steep rate jump is because lenders take a bigger risk offering private student loans to borrowers with low scores, says credit expert John Ulzheimer, who has worked for FICO and Equifax. Unlike a home or auto loan, there's no asset they can claim if you don't pay. "Lending 101: Don't let someone borrow money if you don't expect them to pay it back," he says.
The problem is that students and recent grads tend to have lower credit scores, mostly because you're young and don't have an established credit history. The average credit score for people age 20 and younger is 631, and for those ages 21 to 34, it's 634, according to WalletHub.
Let's say you take out a $5,000 private student loan for your freshman year, and start a 5-year repayment term 4.5 years later — after you graduate and enjoy a 6-month grace period. (Private student loans accrue interest while you're in school as well as during your grace period after graduating.)
At a fixed 8% rate, the balance would be almost $7,200 when you start repayment. With a fixed 2.5% rate, you'd only owe about $5,600.
In all, the better rate would save you almost $2,800 in interest over the life of the loan.
If your score isn't good enough to get a decent rate on a private student loan, one strategy is to ask someone with an established credit score and history, often a parent, family member or trusted friend, to cosign. Using a cosigner is a common move: SavingforCollege.com publisher Mark Kantrowitz estimates around 90% of undergraduate private student loans require one.
But cosigning can be risky for that family member or friend with good credit. Essentially, you're asking them to lend you their good reputation to bolster your application. If you pay late or fall behind on what you owe, lenders can go after the cosigner, says Michael Kitchen, managing editor for Student Loan Hero.
He warns would-be cosigners: "You're taking the same risk as the same person borrowing the loan takes."
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