Wednesday, July 30, 2008

Punishing Students for Comparison Loan Shopping

The NYTimes reports that students who comparison shop may be getting punished with higher student loan interest rates.
How did it come to pass that 18-year-olds were vulnerable to paying more because they shopped around? To answer that question, and develop strategies for credit score damage control, you need to know a bit more about the worlds of student debt and credit score algorithms.

Borrowers took out $17.1 billion in private sector loans in the 2006-7 school year, according to preliminary College Board figures. Part of what makes private loans different from other student loans is that rates can range wildly, by several percentage points, even with one lender.

To quote a rate, lenders check an applicant’s credit history. And every time a shopper asks a lender for a rate quote, it can show up as another inquiry on a credit report.

Lots of inquiries send the wrong signals to the formulas that create the popular FICO credit score that Fair Isaac administers, namely that borrowers may be applying for multiple loans because they’re financially troubled and potentially going bankrupt.

While Fair Isaac has mined years of data to determine that people making a bunch of mortgage and auto loan applications over a short period are almost always innocently shopping for a loan, it hasn’t declared student loan shoppers similarly safe.

One reason is that the company doesn’t have a big pile of private student loan data to mine. These loans are relatively new, and not many people shopped around for the best rate before the student loan scandals erupted.

So, in theory, how much could credit scores fall when people shop for loans? Fair Isaac says that each inquiry will generally not cause more than a five-point drop, though it may be more for a student with a short credit history.

Lenders generally check credit reports with only one of the three main credit bureaus. If a lender examines only one such report, an applicant avoids damage on the other two bureaus’ records. Then again, if all the lenders check with the same credit bureau, the damage may be especially high there.

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