To shop or not to shop? That’s the question when it comes to private student loans.

Every time you apply for credit, the potential lender pulls your credit report. That action can send your FICO score down a few points on average, according to Craig Watts, public affairs manager at Fair Isaac Corp., the company that formulates the FICO score.

The idea is that when someone applies for credit, he is planning to increase his debt load, which makes him a “riskier borrower for the next couple of years,” Watts says.

Multiple inquiries could signal that a consumer is applying for multiple lines of credit. But credit bureaus and score calculators make an exception for consumers applying for home and car loans, provided those applications fall within a set time frame (usually two weeks).

The rationale is that even if you’ve applied to five banks, you’re only going to take out one student loan, so you get hit with one inquiry, not five.

Not so for private student loans.

No consistency on inquiries

And different credit entities will treat the inquiries differently. It isn’t consistent across the board, says Watts. (Bureaus also calculate and sell other types of credit scores that aren’t based on the FICO model.)

With FICO scores, each bureau calculates its own version of your score, based on the information reported to it. But some will count multiple inquiries made within a short period of time for a student loan as one. Others won’t.

“The way the inquiry is coded determines how the FICO score treats the inquiry,” says Watts.

In addition, for those who have spotty credit or little experience with credit, those inquiries “may have more impact,” says Watts.

But lenders aren’t looking for a long credit history with student borrowers, says Harrison Wadsworth, special counsel to the Consumer Bankers Association, an industry trade group. With students, “they’re expecting a very thin file,” he says. “What they would want to see is nothing adverse.”

The average undergrad covers about 7 percent of tuition through private student loans, says Martha Holler, spokesperson for student loan lender Sallie Mae. Students themselves take out more than two-thirds of the loans, while parents account for roughly 29 percent, according to Sallie Mae/Gallup data.

FICO has no plans at present to change the scoring formula so that it automatically groups student loan inquiries as one, says Watts. The purpose of the score is to predict how likely a person is to honor (or walk away from) debt, he says.

“If we go in and start fussing around with the formula based on sociology or politics, the predictive ability would likely drop,” he adds.

But not everyone agrees.

“The problem is that student loans aren’t analogous to credit cards,” says Luke Swarthout, a higher education advocate with the U.S. Public Interest Research Group. “People don’t take out multiple student loan accounts the way they might take out multiple credit card accounts.”

Sallie Mae, one of the largest student loan providers, would like for borrowers to be able to comparison shop without endangering their credit scores, says Holler. “We believe that customers should be able to shop without penalties.”

The last to know

When it comes to students and credit scores, this is one instance where the person most affected may be the last to know.

College students are often so worried about getting enough money to cover school, room, board and books that credit concerns often come last on the list, if they are on the list at all, says Carmen Berkley, president of the U.S. Student Association and recent graduate.

“I don’t know that finance, with regard to credit score, is on the radar,” she says.

But, since an estimated 50 percent to 70 percent of private education loans involve a co-signer (usually a parent), students aren’t the only ones who could feel the sting of lower scores.

For students, who are often first-time borrowers, loan shopping is “a really confusing process,” says Berkley. “It’s confusing for students, and it’s confusing for parents.”

Steps to minimize credit damage

There are at least nine steps students and parents can take to make smarter loan choices and minimize the impact on those credit scores:

9 steps to minimize credit damage

  1. Max out all of your options for federally backed loans.
  2. Talk to your college.
  3. Don’t let deadlines push you into private loans.
  4. Investigate state and local money.
  5. Hit the Web.
  6. Pull your credit history.
  7. Check on the financial health of your lender.
  8. Research the loan before you apply.
  9. Shop carefully.

1. Max out all of your options for federally backed loans before you even consider private loans. Federally backed loans don’t require a credit check (everyone gets the same rate, regardless of credit), so they won’t depress your score. Plus, the terms, fees, and repayment options are generally better.

2. Talk to your college. Your financial aid office can tell you which private lenders other students are using most, and the types of rates and fees they are seeing. They may even be able to tell you about the terms and fees on the loans they’ve seen. Some schools even have affinity programs with lenders, which can give students a better rate, says Kalman Chany, co-author of “Paying for College Without Going Broke.”

Students are sometimes reluctant to use the aid office to their full advantage. And some parents may be wary because, in the past, some lenders and colleges were chastised for being too chummy. But, if you keep your eyes open and do your own research, colleges can be a great source of information you might not get anywhere else. While you’re at it, find out if your college lends money (some do), says Chany.

3. Don’t let deadlines push you into private loans. You can obtain federal money as fast (or faster) than you can get private money, says Chany. File your federal aid application (the Free Application for Federal Student Aid, or FAFSA), online and “and in as quickly as two days, the school can have your results,” he says.

4. Investigate state and local money. Some states have financial aid agencies that lend college tuition money, says Mark Kantrowitz, publisher of FinAid.org. While there are fewer of these than a few years ago, it’s worth finding out if it’s an option for you.

5. Hit the Web. Sites like FinAid.org will help you research the range of rates that lenders are charging, along with some of the fees and terms. Use this data to narrow your list of lenders before you start making applications.

And be careful about making assumptions based on best rate/worst rate information, says Kantrowitz. “Less than 10 percent of borrowers get the best rate,” he says. “Two-thirds or more get the worst rate.”

6. Pull your credit history. Get a (free) copy of your credit report, and pay to get your credit score, too, says Daniel T. Barkowitz, director of student financial aid and employment at MIT. If your parents will be co-signing, have them do the same. When you talk with lenders, advise them of the credit scores, and ask what kind of rates and terms they can offer. Just how open and precise are they willing to be?

7. Check on the financial health of your lender. Worst case scenario: You shop around, find a great rate, and the company goes under or stops making new loans, says Chany. Now you have to take your history and your score (which could be lower thanks to the first round of shopping), to a new lender, and you might not get as good a rate. Check your bank’s rating first.

8. Research the loan before you apply. Since many of the same lenders broker both public and private money, it can be confusing to borrowers, says Chany. “A lot of people went for private loans thinking they were getting federal loans,” he says.

Before you apply you need to know: What is the loan? How much will you receive? Who is the lender? What is its reputation? Is the loan private or government-backed? What is the range of rates? If the rate is variable, how is it calculated? Is there a cap on the rate? What are the fees? What are the repayment terms?

9. Shop carefully. After you narrow your list, limit the number of applications you file. Advice from advocates and loan consultants varies, but the general rule of thumb is to keep your applications to three or no more than four. Keep those applications within a two-week period. (Kantrowitz even recommends keeping them within one week.) That way, if the bureau bundles them for the purpose of calculating your score, they’ll count as one. And if it doesn’t, since the inquiries won’t be rolled into your FICO score for a month, you’ll have a couple of weeks to make your decision before your score is affected.

And while the inquiries will be dropped from your credit report in two years, they will only affect your FICO score for one year. That means that when you apply for a loan next year, you should have a clean slate.

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