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Options for a Family Denied Education Loans Due to Insufficient Income

Mark Kantrowitz

October 04, 2010

My daughter received some financial aid for her freshman year of college but we still had to take out a sizable loan for the rest. She applied for a loan her sophomore year and was denied because we have “insufficient income” to repay the debt. My husband is self-employed as a landscaper and it was a bad year. She was attending a private college and had to quit because we couldn’t get the loan. If she attends a state college do you think she’ll get a loan? Our credit is pretty good. Is there a starting income level that you need to have to get a loan? — Andi W.

There are two types of education loans, federal and private. The loan that was denied because of insufficient income was a private student loan.

You should always borrow federal first, as federal education loans are cheaper, more available and have better repayment terms. Federal education loans have fixed interest rates, while most private student loans have variable interest rates. The interest rates are fixed at 6.8% for an unsubsidized Stafford loan (lower for a subsidized Stafford loan) and 7.9% for a Parent PLUS loan. The current interest rates on private student loans may be lower for borrowers with excellent credit, but the interest rates are variable and are likely to increase significantly over the next few years, ultimately costing more over the life of the loan.

Federal education loans do not depend on credit scores or debt-to-income ratios. Your income level does not affect your eligibility for a federal education loan. You can qualify for federal education loans regardless of whether you are poor or wealthy. The unsubsidized Stafford loan and the PLUS loan do not depend on financial need.

The federal Stafford loan, a student loan, does not consider your credit history or income at all. You can have subprime credit and no income and still get a Stafford loan. Annual loan limits on the Stafford loan vary from $5,500 to $7,500 for a dependent student and from $9,500 to $12,500 for an independent student, depending on year in school. Cumulative loan limits are $31,000 for a dependent student and $57,500 for an independent student.

The federal Parent PLUS loan, a loan for parents of dependent undergraduate students, has a modest credit check. Borrowers must not have an “adverse credit history”. An adverse credit history is defined as having had a bankruptcy, foreclosure, repossession, tax lien, wage garnishment or default determination in the last five years, or a current delinquency on any debt of 90 or more days. Parents may borrow up to the full cost of attendance each year, minus other aid received. There is no cumulative limit. If a parent is denied a Parent PLUS loan, the student becomes eligible for the increased Stafford loan limits available to independent students. Parents who are denied a Parent PLUS loan also have the option of getting a creditworthy endorser or reapplying after they no longer have an adverse credit history (i.e., by making payments to eliminate any 90-day delinquencies or by getting inaccurate derogatory information removed from their credit history).

Private student loans usually require the borrower to be creditworthy or to have a creditworthy cosigner. More than 85% of all funded private student loans have a cosigner. Eligibility is typically based on the higher of the borrower’s and cosigner’s credit scores. The credit score also determines the interest rates and fees, with a higher credit score yielding a lower interest rate and/or lower fees. The stated minimum credit score on most private student loans is currently 650, as “recourse loans” to borrowers with subprime credit scores were eliminated during the credit crisis. In practice, however, many lenders seem to be requiring a minimum credit score of 750-780.

Lenders have also modified their use of automated underwriting for private student loans. Before the credit crisis one could get automatic approval or denial for a private student loan within minutes. Today the loan denials are immediate, but in most cases the approvals will be subject to “secondary confirmation” where the credit history is reviewed by a person before the loan is approved. Common criteria for rejecting a loan application despite a good credit score include minimum income thresholds, volatile income and self employment. Minimum income requirements typically vary from $18,000 to $25,000, but debt-to-income thresholds may implicitly require a higher minimum income threshold due to higher debt. The lenders sometimes consider total debt outstanding, year in school, degree program and field of study. Some lenders have considered the college’s default rate on federal education loans when deciding whether to approve private student loans for students at the college.

Federal education loans are obtained through the college’s financial aid office. Private student loans are obtained directly from the lender. Some colleges have lists of recommended lenders, which are a good starting point. There are also several loan comparison sites for private student loans. It is worthwhile to shop around for a private student loan, as each lender’s policies and rates are different.

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