When it comes to paying for educational expenses, many college students require student loans. More than half of American students and families have to borrow money to pay for a college education. One way to get the money to pay student bills is through scholarships, grants, and federal student loans. Another way is through private student loans, which is only recommended after you have exhausted all of your other options.
Federal student loans are the most affordable solution for every student, and you might qualify regardless of your credit, financial need, or grades. However, there’s a loan limit to how much you can borrow with subsidized and unsubsidized federal loans. That creates the gap between any federal student aid and the total cost of attendance. Private student loans can cover this gap and might be the solution you need to get that degree.
This guide will help you understand how private student loans work, their benefits and drawbacks, as well as what to look for when searching for the best private student loans.
What Are Private Student Loans?
Private student loans come from private banks, credit unions, schools, state agencies, or financial institutions. These non-federal education loans are also called alternative student loans. That is because you should always borrow federal student loans before private loans. Only once you have taken advantage of all federal student aid opportunities and borrowed the maximum in federal loans, you should consider applying for a private loan.
Private student loans have terms that are different from federal student loans. With federal student loans, which are funded by the federal government, there are standard interest rates, fees, and types. Private loans, on the other hand, are financed and set by a private lender. That means that interest rates, fees, and repayment terms vary significantly between loan programs and lenders. They also depend on factors such as your credit, or your cosigner’s credit.
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What Can Private Student Loans be Used For?
All student loans, including both private and federal, can be used to pay for education expenses. In addition to tuition, they might also include:
- Room and board
- Supplies and equipment
- Miscellaneous personal items (computers) for school
Types of Private Student Loans
There are different types of loans available to student borrowers, depending on the degree they are pursuing. The lender sets the loan amount, interest rate, and terms according to the type of the loan.
Community College Loans
With a rising number of students opting for community college, private lenders have started to offer loans to students attending 2-year colleges, career-training programs, and technical schools. Some of the most prominent national private lenders who offer these types of education loans are Wells Fargo and Sallie Mae.
Undergraduate School Loans
Students who are pursuing a bachelor’s degree can apply for undergraduate loans to cover the cost of tuition, which is approximately $22,000 per academic year. In comparison to community loans, undergraduate loans usually have higher loan limits and lower interest rates.
Students attending school for a master’s degree or doctorate have higher tuition costs than undergraduates. For this reason, lenders offer higher maximum loan amounts and have special loan programs for medical, law, or business schools.
Private student loan lenders offer parent loans to students’ parents, relatives, or another creditworthy individual to cover college expenses. The parents, not students, have to repay the loan.
Variable and Fixed Interest Rate Loans
Private student loans usually have variable and fixed interest rates that the lender sets based on the credit score of the borrower. Once you choose an interest rate type, you may not be able to switch, so think before you make a decision.
Interest rates depend on your credit history. If you have a good credit score, you will qualify for a lower interest rate. But if you have poor credit, you might have no other choice than to take a high-interest rate.
Private Student Loans with Fixed Interest Rates
A fixed interest rate doesn’t change throughout the life of the loan, which means that your monthly payment will stay the same. With a fixed interest rate, you don’t have to worry about how the market fluctuates. The rate you get depends on different factors, including your credit, current market rates, the lender, and the terms of the loan.
The fixed interest rate for federal student loans for the 2019/2020 school year is at 4.53% for undergraduate students, while parent loans are at 7.08%. Banks, credit unions, and other institutions offer private loans with low rates that are intended to beat the federal loan rates. For example, Sallie Mae has fixed rates that range from 5.49% to 12.87% APR.
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Private Student Loans with Variable Interest Rates
A variable interest rate fluctuates and depends on the index it follows. It can be based on either the London Interbank Offered Rate (LIBOR) Index or the Prime Index. A variable interest rate rises and falls periodically depending on market changes. Likewise, your monthly payment will increase or decrease as the interest rate rises and falls.
A loan with variable interest rates usually starts with a lower initial interest rate than a fixed-rate loan. It could remain lower, but there is a risk it may increase over the life of the loan. It could lead to an increase in your monthly payment and the total cost of borrowing. A variable interest rate loan might be the right choice for a borrower who can afford higher monthly payments. Especially if the interest rate increases and you quickly repay the loan.
Loan Terms and Limits
Private student loans have different lengths of repayment terms that can range from 5 to 20 years. Loans with shorter repayment periods have lower interest rates and total costs, but their monthly payments are higher. Loans with more extended repayment periods have higher interest rates and lower monthly payments. When it comes to private loan limits, there are minimums and maximums.
The majority of student loan lenders offer a minimum amount a student can borrow. Loans could be as low as $1,000, but minimum loan limits vary, depending on the state. However, you need to be very careful and borrow what you need. If you only need a few hundreds of dollars and the minimum is $1000, perhaps you should look into other options.
There are several types of borrowing limits for student loans:
- Annual limits – the maximum amount a borrower can receive in a single year.
- Aggregate/cumulative limits – the maximum amount a borrower is allowed to get during their education, including both federal and private student loans.
- COA (cost of attendance) limits – a borrower must not receive the loan amount higher than the school’s certified cost of attendance minus other loans received. COA limit is designed to prevent the total financial aid from exceeding the college’s total cost of attendance.
If you are uncertain about how much to borrow, think about how much you could make in your career field. How much do you think you can afford to pay back? Also, go to the US Department of Labor website to estimate your future income potential.
Private Student Loan Repayment Plans
Private student loan lenders offer a few repayment options to choose from. Here are the most common ones.
You start repaying your loan immediately after loan disbursement. That means that you need to make full payments while you’re still in school, which might be challenging for some borrowers. There are also benefits of this repayment option, such as:
- A lender might offer a lower interest rate
- You will save the most money on interest
- You will pay off your loan faster.
You pay only the accrued interest while you are still in school. When you graduate or drop below half time, you pay principal and interest. Interest-only payments are much smaller than principal and interest payments. The primary benefit of this payment option is that the interest will not be accruing while you are in school, which will save you money on interest. On top of that, you might save money overall as loan lenders might offer lower interest rates if you opt for an interest-only repayment plan.
While you are in school, you make small fixed payments. After you graduate, you start making regular principal and interest payments. The amount of monthly payments is lower than full interest payments.
You don’t make any payments while you are in school. Six months after you leave school, you will start making principal and interest payments. Full deferment is the most expensive option because the interest rate continues to accrue the entire time and is added to the loan balance.
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Differences Between Private Student Loans and Federal Student Loans
There are many differences between federal student loans and private student loans. The most relevant differences are in the lender, interest rates, loan limits, repayment options, subsidies, approval and cosigner requirements, loan forgiveness, and default periods.
The lender of federal student loans is the federal government. Private banks, credit unions, schools, and other lenders offer private student loans.
Federal student loans offer fixed rates, which gives a borrower a sense of stability regarding their monthly payment. The federal government stopped making variable-rate student loans in 2006.
On the other hand, private student loan programs offer variable interest rates, which may fluctuate depending on the market. However, they also offer loans with fixed rates that can be lower or higher than federal rates, based on the credit scores of the borrower and cosigner, if any.
As opposed to federal student loans, private loan programs generally offer higher annual and cumulative loan limits.
With federal student loans, payments aren’t due until after graduation. You start paying off your debt after you leave school. They also offer a grace period between six and twelve months after graduation. A grace period is a time between graduation and when you need to begin making payments on the loan. There is no prepayment penalty fee with federal student loans.
Repayment terms of many private loans require payments while you are still in school. Some private loans have a grace period, while others don’t. Some loan plans allow borrowers to put off payments if they return to school full-time, which is called an in-school deferment, or due to financial hardship, called forbearance. Some private loans might even charge prepayment penalty fees.
In case of a financial need, a borrower might qualify for a subsidized loan. Subsidized loans do not accumulate interest while you are in school, which means that the government pays the interest during the grace and in-school periods.
Private student loans are often not subsidized. Unsubsidized loans begin accruing interest immediately, and the borrower is responsible for all the interest until the loan is paid off.
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Approval and Cosigner Requirements
With federal student loans, the approval is based on expected family contribution and the Free Application for Federal Student Aid FAFSA. To qualify for this loan, you don’t need to get a credit check. Federal student loans do not require a cosigner.
Private student loans depend on your credit history. They require an established credit record or a creditworthy cosigner if a borrower hasn’t had enough time to build their credit. Most private lenders require a co-signer.
Loan Forgiveness (or Discharge)
You can have federal student loan debt forgiven if you join the military, get a public service job, or apply for the Income-Based Repayment Plan. You can apply for loan forgiveness under the Public Service Loan Forgiveness Program.
Many lenders do not offer loan forgiveness programs. However, there are circumstances in which loans offered by states can be forgiven.
Loan default is when a borrower fails to pay a loan debt as agreed and misses monthly payments. If you default on either a federal or private student loan, the entire loan balance is due immediately.
With federal student loans, the period between missing a payment and having the loan default (delinquency period) is 270 days or roughly nine months. With private student loans, the delinquency period is three months.
Private Student Loan Application Process
Applying for private student loans is quick and easy. It is also usually free. You can apply directly from each lender’s website within 15 minutes. A borrower should apply for a private student loan only after they know how much they need to borrow and have made their school choice. This general rule exists because lenders send the loan certification form to the borrowers’ schools.
After you choose a lender, you will need to provide some personal and financial information, including:
- Your address and Social Security number
- School-related information like the course of study
- Academic period of enrollment and year in school
- Requested loan amount
- The financial aid you expect to receive
- Other financial information
When applying for a private loan, you generally need a co-signer. If you do, you will also need to provide their financial information in your application. Additionally, you will choose the type of interest rate and repayment options.
Finally, if the lender lets you know that you’re eligible, you sign the promissory note. This is a legal contract between the lender and borrower that legally requires a borrower to pay back the student loan.
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Private Student Loan Eligibility Requirements
Each lender has its eligibility requirements. With most private student loan programs, those requirements include:
- Credit score
- Debt-to-income ratio
- College or university
- Proposed field of study
Students with higher credit scores and income might get loans with a lower interest rate and for a higher amount. Generally, you will need to have an average credit score of 700 to be eligible. According to statistics, the average credit score required for a private student loan in 2017 was 739. However, if you do not have a good credit score or you are an undergraduate with no income or established credit, you might need to apply with a cosigner. Also, some loans don’t require a cosigner but base eligibility on the borrower’s career and income potential.
Since most private student loans are school-certified, you need to be enrolled to be eligible for a loan. The lender will check this information with your college or university’s financial aid office. They will also check the maximum amount you can borrow, taking into account other financial aid you have received.
And finally, to qualify for any financial aid, you need to file the Free Application for Federal Student Aid (FAFSA). You are not required to file FAFSA when applying for a private student loan, but it is highly recommended. Filing a FAFSA ensures that you will receive all of the federal financial aid for which you are eligible.
Co-Signer Private Student Loans
As mentioned earlier in the text, you will need a cosigner to get a private student loan if you have no income and no credit. You will also need one if you have bad credit. Statistics show that 90 percent of all private student loans require a cosigner. A cosigner is a person who signs a loan contract along with the borrower, agreeing to make payments if the borrower does not.
A cosigner is required when a borrower has no credit card, car loan, utility, or other bills to show they can make payments on time. A cosigner needs to have a good credit score and a steady income — the higher the credit score, the lower the cost of a loan. If a cosigner doesn’t make payments on time, it will damage the credit of both the borrower and cosigner. If, on the other hand, a cosigner makes payments on time for the first few years, a lender might offer a co-signer release program. But, the primary borrower also needs to meet criteria like having a high credit score and a stable job.
Private Student Loan Downsides
Although they have several benefits, private student loans come with significant risks. Before making their final decision, borrowers should carefully consider the following downsides.
Good Credit Requirement
To qualify for a private student loan, an applicant needs to have good credit. And since many borrowers have unstable income and limited credit history, they may not be able to get approved without a cosigner. Or, they might end up with a high-interest rate.
Without a cosigner, many student applicants wouldn’t be able to qualify for a private student loan. However, co-signing involves risk for several reasons. First, if a borrower stops making payments, it could hurt the cosigner’s credit. Second, if a borrower becomes disabled or dies, the co-signer will be responsible for the loan debt. Even worse, if this happens, the entire balance could be due.
Higher Interest Rates
It is possible to score a low-interest rate with private student loans. However, chances for that are low, especially if a borrower or cosigner has poor credit and low, unstable income. You could end up paying more over time with a rate that tops a federal interest rate.
Additionally, with subsidized loans, the government pays interest when the loans are in delay, such as while you are in school. Private student loans accrue interest rates during these periods.
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Private Student Loan Fees
There are fees that a borrower might incur for some private student loans, such as:
- Origination fee
- Application fee
- Late fee
- Prepayment penalties
If a lender adds some of these fees, a borrower’s cost of education will undoubtedly rise.
Variable Rate Risk
If you think you will save money by opting for a variable interest rate, think twice. There is always the possibility that the variable rate will increase over time because of its dependence on the current market interest rate. Rates are currently going up and will probably continue to rise. So, even if you receive a lower initial rate, there’s a risk of it increasing over the life of the loan.
Limited Hardship Options
One of the most significant downsides of private student loans is limited options regarding financial hardship. If borrowers have difficulty making their monthly payments, unsubsidized loans will offer few programs, such as:
- in-school deferment
- income-driven repayment options
Some private loan lenders offer these options, but it is hard to qualify for them.
Where to Find Private Student Loans
Before you start looking for private student loans, you must find a reputable lender that will offer the lowest interest rate and a payment schedule that fits you. You can start the search at your school. They probably have a list of lenders that work with them. Next, you can ask others for recommendations. And finally, ensure to choose a loan appropriate for your program, because there are different loans for undergraduates, graduates, etc.
Credit unions are nonprofit lenders that offer private student loans with lower rates and more favorable terms than banks. Two of the most trusted and popular student loan providers used by credit unions are Student Choice and CU Student Loans. You can also check Ascentra Credit Union.
Sallie Mae is one of the most renowned private student loan lenders. It offers loan terms that range from 5 to 15 years, with no origination fee, application fee, or prepayment penalty. It also provides generous repayment options, including interest-only, fixed payment, and deferred interest. For information on rates, check the Sallie Mae website.
Sallie Mae is one of few lenders whose loans are available to both full-time and part-time students.
Discover offers great loan options to struggling borrowers. Discover, best known for its credit card business, launched its Discover Student Loans in 2007. In comparison to other lenders, it offers more flexible options to borrowers who are struggling to make payments. There are also no late fees, which is a significant benefit. On the other hand, a co-signer release is not available, and they only offer 10- and 20-year repayment terms. Check their rates here.
Credible is a marketplace where borrowers can shop around for the best private student loans and student loan refinancing. This free website enables you to compare dozens of private lenders and their rates and terms, based on your degree program, credit score, school, etc.
Credible doesn’t do any lending itself.
Top 3 Takeaways
Students who are looking for ways to cover their college expenses should first focus on free money, such as personal savings and gift aid (scholarships, and grants). Only after they have exhausted free money options, they should look into federal student loans for financing remaining college costs. That is because they have more flexible deferment and repayment terms, and are less expensive. Only after exhausting eligibility for this option, you can consider private student loans as a last resort. But, borrow and manage your debt smart.
There are many options to choose from when it comes to private student loans. But, this also means that there is a wide variety of interest rates, loan terms, and fees. Compare to find the lowest-cost loan that also provides borrower protection. Shop around online because some of the best private education loan providers operate online.
It is recommended that you only borrow the amount you will need. Borrowing more than necessary will result in a mountain of debt after college, which could lead to financial trouble. To keep your debt under control, you should stick to a budget while you’re in school.
Do you have any questions about private student loans? Would you like to share some tips with other readers? Let us know in the comment section below!