A commonly asked question is if a credit score affects your ability to receive federal student loans. And similarly, does receiving financial aid have an impact on your eventual credit score? This is a great question because it covers credit, debt and loans in the context of financing education today and implications for the future.
Financial Aid & FAFSA
In order to receive federal loans and grants, students are first required to complete the FAFSA. There is no other alternative to be considered for federal student aid. As these options are need-based, a credit score is not required.
In addition, submitting the FAFSA does not automatically enroll you in loan options. Once a school receives your FAFSA results, they will calculate a financial aid package — sometimes this is shared in the form of an award letter. The award letter typically spells out the different types of funding sources, which include can include federal loans and grants, work-study options, and so on. Every award letter is a little different and must be read carefully. It’s also worth mentioning that award letters can be negotiated.
Ultimately if a student elects to accept the loan offerings, the student will be required to pay back these loans. In other words, parents and guardians are not cosigners or liable for a student’s federal loans.
When do credit scores apply to student loans?
Sometimes your award letter doesn’t provide enough money to pay for tuition and other expenses. If you do not have other outside scholarships or funds saved, you may need to consider other financing options.
If you decide to apply for private student loans, you (or your parents) will likely have your credit score checked. This is because the lender, read more below, will need to review your credit history before lending money. This also applies if you opt to refinance your student loans or fail to make timely and adequate payments on existing loans.
Credit scores also play a role in obtaining a Parent PLUS Loan with your parents. If the cosigner, in this case one of your parents, doesn’t have a strong credit score, it may prove to be challenging to obtain more funds through a Plus Loan.
Credit score basics
First of all, what is a credit score? In the most basic sense, a credit score is a measure of ability to pay back debt in a timely fashion. Most of us think about credit scores as a number that ranges from 300 to 850, or so. A higher score is better than a lower score in the sense that lenders will be more likely to lend more money at a lower interest rate.
Credit scores increase when borrowers show a history of paying back their debts in timely fashions. Missing payments or taking on more debt than you can manage can hurt your score. Credit scores fluctuate overtime, but can still be improved with good financial habits.
An entire article could be dedicated to interest rates on loans. But to simplify, a lower interest rate on a student loan is generally more favorable than a higher interest rate. The reason is that banks charge interest on loans in order to profit. So over the course of the loan, you would owe less total interest on top of your original loan.
How to check your credit score
Are you curious about your credit score or working with your parents or guardians to assess options? Here are a few free and legitimate resources to help guide you:
- Creditkarma.com – maybe you have seen their ads on TV or online, but they are a good resource. Keep in mind there are some sponsored ads for credit cards and loans.
- The FTC also provides a link for consumers to get access to free annual credit report.
Remember, using the above sources to check your score won’t hurt your credit score. It’s a good idea to periodically review your score for any inconsistencies or errors. Your credit score can be your financial ally, be sure to protect it.
Concluding tips for new borrowers
If you have not already, make sure you file your FAFSA before the deadline. As a reminder, you should seek outside loans only after you have filed the FAFSA as you may be eligible for grants (free money) and work-study options. This will help you reduce your overall loan burden.
The student loans that you choose to accept ultimately become part of your credit score. But remember that establishing credit is not a bad thing if you do it responsibly. In order to borrow money in the future for bigger purchases, you will need to show history of loans. Otherwise a bank or lender does not have any proof or idea if you can pay back your debt.
Student loans have long repayment terms and this gives you the chance to make timely repayments on a fairly large investment for your future. Thus helping to grow and build your credit.
Lastly, if you want to avoid any debt at all, check out our article on no loan colleges.