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Getting Student Loans When You Have Bad Credit

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The credit crisis has everyone on edge. If you are planning to take out student loans to help pay for your college education, you, too, may be worrying about how this financial crisis is going to affect you.

If your credit rating isn’t all that good, your worry is probably pretty intense. But before you hit the panic button, take a deep breath and read this post… it’s got everything you wanted to know about getting a student loan in spite of your credit score!

Apply for federal student loans first
Remember that there are two kinds of student loans: those that are guaranteed by the federal government and those that come directly from private lenders without government guarantees.

Government guaranteed loans take the form of one of three types: the Stafford Loan, the Perkins Loan or the PLUS (Parent) Loan. To qualify for a federal student loan, your credit score does not matter. The lender can’t even pull a credit report. The loan is strictly need-based. So if the federal government determines that you qualify, then you are entitled to take out the loan. Period. Plus, not only are you off the credit score hook, but you will also fare better in terms of interest rates and terms when compared to a comparable private loan.

Bottom line: Whether you are worried about your credit score or not, you should absolutely fill out the Free Application for Federal Student Aid (FAFSA) and find out which federal student loans your qualify for — and how much. If that amount, plus any other financial aid money (grants, scholarships or work-study), is insufficient to cover your education costs, then and only then, should you look into private loans, which do heavily weigh your credit score.

Ask someone to co-sign for you
Your credit score will be considered strong if you go apply for a private student loan. As a result of the credit crisis, approval standards for private student loans have tightened up considerably. Approval for a lower-interest rate loan, for example, might require a FICO score in the mid to high 700s. For most young college students, a score this high is just not realistic. Especially if you’ve never even had a credit card in your name only — or any other means to establish credit. (If you have no idea what I’m talking about, check out this page on how to establish credit.)

Even with a decent credit score, your interest rate and terms will likely be (much) more favorable if you have a cosigner. Consider carefully whom you ask to cosign for you — and ask them to do the same. A parent or relative is the most common choice, although your cosigner does not have to be a blood relative. Remember: In the event that you fail to live up to your commitment to pay back this loan, the lender will go after your cosigner for the difference. In other words, you are asking a lot more of your cosigner than just his or her John Hancock.

Minimize other debt
If you want to get approved for a student loan and your credit score is iffy, one negative factor might be your debt-to-income ratio. Let’s say you made $9,800 last year at your part-time job. Let’s also say that you owe $11,000 on a car note. Your debt-to-income ratio is completely out of whack and you therefore are not considered a good credit risk. If you can substantially pay down that car debt, your ratio will swing back into balance, making you a better candidate for loan approval.

Be prepared for higher interest rates
If you have bad credit and you get a cosigner will less than stellar credit, you may be “lucky” enough to get approved — but your interest rate will likely be much higher.

According to SmartMoney.com, interest rates on private student loans has gone up markedly in the last year. The average now hovers between 12% and 14%, up from 10% to 11%. Loans for students with bad credit is hitting closer to 19% — higher than many credit cards charge. Interest begins to accrue immediately on a private student loan.

Start small to build credit
If you have to go the way of private student loans, start with as small a loan as possible your first year. While you can typically freeze repayments during your studies, you might want to consider making monthly payments anyway (if you can swing it with a part-time job, for example). Just make sure you can faithfully make those payments, on time, every time. Once you start paying back on the loan, your credit score will improve because you are establishing a reliable pattern of credit-worthiness. By the next year, you can hopefully qualify for a lower interest private student loan — maybe even without a cosigner.

Talk back: Are you considering taking out a private student loan? What’s your experience been like when talking to private lenders? Are they willing to work with you without a cosigner?

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