Shopping for Student Loans Damages Credit Scores

Fact: Too many credit inquiries can damage your credit. That's because the credit scoring formulas assume that the borrower is financially troubled and may even be going bankrupt.

Fact: If you comparison shop for a mortgage or car loan to try to get the best interest rate, FICO's secret credit scoring algorithms lump together all related inquiries that occur within a short period time. Such credit inquiries have a relatively neutral impact on credit scores.

Fact: The New York Times recently reported that students and parents shopping for the best rates on private student loans DO NOT benefit from the same type of calculations as those shopping for home or auto loans. Translation: each time you compare a new student loan, your credit file gets dinged with another inquiry. Each inquiry can drop your score up to 5 points.

It's a bad equation for students and parents:

Too many inquiries = lower credit score.
Lower credit score = higher rates on student loans.

If you have a thin credit history (as many students just getting out on their own often do), such inquiries may have an even greater impact. Anyone who has shopped for a mortgage knows that a measly five points can make a big difference in qualifying for that higher tier interest rate break.

Apparently the New York State Attorney General's office has stepped in and asked Fair Isaac, creator of the FICO score, to treat student loan borrowers the same as those shopping for mortgages and car loans. The Times reports that Fair Isaac isn't changing its policy any time soon and believes its policy doesn't cause any damage most of the time.

However, at least one credit bureau – Experian – confirmed that that this policy may have an impact on credit scores. And a spokesperson for Sallie Mae, the nation's largest private student loan lender, says the company does, in fact, see the negative impact on credit scores and believes that students should not be penalized for trying to make smart financial decisions.

The Times still recommends comparison shopping with 3-4 lenders, preferably within a week or two. Fair Isaac did say that IF there is any negative impact on credit scores, it is more likely to occur when people apply to smaller or specialized student loan lenders, and a lesser impact when applying to big banks.

The Times' advice:

"Start with a lender or two that your college recommends, since it may have negotiated special terms with them... [shop] one bank, one finance company that specializes in student loans and then [look] for nonprofit loan agencies that work with people in the state where you live or the state where you attend college (or both, if you’re lucky enough to have a choice)."

Check this list of lenders or ask people in the financial aid office whether a nonprofit lender serves the college.

I Never Said You Could Pull My Credit!

Dear Credit Mama,

I got a copy of my credit reports and noticed what appears to be a list of companies that have pulled my credit… companies that I had contacted about their service but never actually did business with or authorized to pull my credit. Don't businesses have to get permission to run a credit report? And should I do anything about this?

-- Danielle


Dear Danielle,

Yes, you are correct – under the Fair Credit Reporting Act, businesses must have your permission or a "permissible purpose" to pull someone's credit. (Permissible purpose means they have a legitimate need for the information.)

Merely inquiring about a service does not give the company the right to run your credit report. Companies should tell that they are pulling your credit or ask for your permission first. Employers must get written permission from you in order to check your credit.

These types of inquiries – known as "hard" inquiries – can have a negative impact on your credit score and will typically remain on your credit report for a year, sometimes up to two years.

Although the impact may be relatively minimal -- five points or so per inquiry -- recent studies show that an increase of just 30 points in one's credit score can have significant financial benefits… which means every point in your favor is important.

Hard vs. Soft Inquiries

Hard inquiries include requests for new credit (credit card or loan, or increase in credit card limit), employment credit checks, and applications for certain services such as cell phones or utilities.

Soft inquiries occur when your creditor reviews your files, creditors extend you offers of credit, or when you pull your own credit.

Action Steps

When inquiring about services, be upfront and let them know that you do not want your credit pulled without your permission.

If you believe that the companies listed on your credit report did not have a legitimate reason to access your credit, you can contact the company and request that they correct the information. You also can contact the credit bureaus directly to correct your report.

If the company is in the wrong and refuses to correct the information, you can sue them for up to $1,000 in statutory damages for violations of the Fair Credit Reporting Act.