Private Student Loans for College

    Private loans for college are fraught with negatives, including high interest rates and unforgiving repayment schedules that often end in lawsuits for many borrowers. Unlike government student loans that typically come with low interest rates and generous repayment terms, private loans require high credit scores to qualify and rigorous payment plans that have a nasty reputation for producing defaults. They’re the student loans of last resort, the ones college students turn to when all the family aid, grants, scholarships and federal loans aren’t enough to cover academic expenses.

    Nevertheless, they remain an important part of the college-funding pipeline, with $108 billion in outstanding debt, yet are small compared to the nation’s $1.4 trillion federal student debt market. Sometimes called alternative education loans, they’ve been associated with predatory lenders and for-profit colleges that prey on borrowers’ desire for higher education.

    Not all private loans fit the profile. Banks offer private loans and are reputable lenders. But other non-bank operators have given this form of lending a well-deserved reputation for greed and abuse. In most cases, these are loans you should consider only after you’ve exhausted borrowing options with more lenient terms, such as federally funded Stafford, Perkins and PLUS loans.

    If you decide you need a private loan, remember the adage “buyer beware.”

    Basic Private Student Loans

    Private student loans aren’t backed by the government and come with stricter qualifying requirements, among them a solid credit score. They aren’t issued based on financial need, but on the applicant’s creditworthiness. This means you do not need to complete a Free Application for Federal Student Aid (FAFSA) or any other federal applications, but you likely will have to document your ability to repay the lender.

    Though it’s not required, experts suggest you complete the FAFSA anyway. Completing it will tell you if you are eligible for better financial aid options such as grants, federal loans and work-study.

    Loan offers can vary dramatically, so explore all options carefully. If you don’t have a credit history, you will need a cosigner to qualify. You should carefully review the loan terms and go over them with your designated cosigner, since that person will be liable for the debt if you are unable or unwilling to repay it. Lenders’ terms vary, differing on payment deferment options, interest rates, repayment plans and loan limits. And unlike federal loans, private loans often come with variable interest rates, which means you’ll monthly payment can change during the life of the loan.

    A variety of lenders make private student loans, including:
    • Commercial Banks
    • Credit Unions
    • Community Banks
    • Online lenders
    • Sallie Mae (a large private lender)

    Picking the right lender requires care. Be ready to ask questions about how large a loan business the lender has and how variable interest rates are computed. Also Google the lender and check government web sites to see if the lender has received complaints or has been sued.

    Other steps to consider:
    • Check with your college or university to see if it offers a list of recommended lenders
    • Confirm that the lender works with your school
    • Talk to others – especially fellow students and graduates – for recommendations
    • Understand the loan and confirm that it is the right one for the academic program you’re entering. Different programs can have different loans available.

    You should also consider how much you’re willing to borrow from a private lender. Different degree programs require widely varying amounts of time to complete, and graduates can earn substantially different incomes. Understand your program and your income potential before taking on debt. The College Board recommends that your monthly loan payments not exceed 10% to 15% of your starting monthly salary.

    Private Loan Uses

    Like federal loans, private loans can be used for many purposes, but remember student loans are designed to pay for academic expense, not entertainment.

    Here are the sorts of things they’re designed to cover:
    • Tuition
    • Room and board
    • Academic fees
    • Books, supplies, computers and electronics, and classroom equipment
    • Personal needs and transportation

    Borrowed money shouldn’t be spent on vacations, concert tickets, streaming audio and video accounts or anything else that’s not directly related to your studies.

    Comparing Private Loans

    Assembling a group of potential lenders is just the first step in deciding where to borrow. Once you have the candidates lined up, compare the options to decide which loan will work best for you.

    Some important things to consider:
    • What are the private loans’ interest rates? Is it a variable rate loan or a fixed one, like federal loans? If it is variable, how does it change and does it have a cap?
    • Are you required to begin repaying the loan while you’re still in school? If so, how much will you need to pay? Will you just repay interest while enrolled or interest and principal?
    • Are there any steps you can take to lower your interest rate during the repayment period?
    • What can you learn about the lender? If the lender reputable and how long has it been in the student-loan business?

    Payment Deferment

    Many lenders allow you to defer all payments until after you’re done with school. Some even provide you with a grace period of 6-9 months, meaning you won’t have to begin repaying your loan until after you’ve been out of school for a while.

    Other lenders may require you to make some payments while you’re still in school. You may have to pay interest only each month, or you may have to start repaying the principal amount immediately after finishing school. Again, it’s important to understand your obligations before borrowing.

    Interest Rates

    Most private student loans have interest rates tied to the economy using LIBOR or PRIME, two widely used interest-rate indexes.

    LIBOR, the acronym for the London Interbank Offered Rate, tracks what it costs banks to borrow money from other banks. It represents the recent average interest rate earned by deposits in the London market.

    The PRIME index, short for Prime Lending Rate, reflects the lowest interest rates currently offered by banks.

    The interest rate offered on an education loan will be close to one of the indexes.  An interest rate of LIBOR plus 2.8% means your interest rate will be 2.8 percentage points greater than the LIBOR index. Currently, an interest rate of LIBOR + 2.8% is roughly equal to PRIME + 0.0 percent.

    The best interest rates available are typically LIBOR + 2% and PRIME – 0.5%. It is usually better to have an interest rate tied to LIBOR. These rates typically grow more slowly than those tied to PRIME and could save you money in the long term.

    Be aware that your interest rate may be introductory and may only last while you are in school and during a grace period. After that, you may be charged a higher interest rate.

    Also look at the fees. A lower interest rate may mean higher fees.

    Repayment Plans

    Repayment terms vary by lender and may depend on the size of your loan. Most lenders have maximum repayment terms of 15 to 25 years. More time to repay a loan will lower your minimum monthly payments, but you’ll wind up paying more in interest.

    It’s wise to begin paying off a private loan as soon as you can, even if the required repayment period hasn’t begun and you’re still in school. The faster you can lower the amount of principal you owe, the lower your interest payment will be on the remaining balance and the sooner you will get out of debt.

    You can consolidate private student loans. Terms vary depending on your credit score, income and other variables.

    Maximum Loan Amounts

    Some lenders have maximum loan amounts cap your annual and total borrowing amounts, regardless of your actual costs. Lenders may cap undergraduate loans at or around $30,000 a year. Cumulative or total loan limits are usually around $120,000 or $150,000 for undergraduate studies. Graduate and professional students have higher limits.

    Other lenders allow you to borrow up to the full cost of your education. If that’s the case, your college or university will estimate the annual cost of attendance, including tuition, living expenses and other financial need and you’ll be able to borrow up to that amount.

    Specialized Private Student Loans

    Federal student loans are not available for law and medical students after they graduate. These students can instead turn to private loans if they have more educational expenses.

    A Bar Study Loan is awarded to law students to help pay for bar exam costs and living expenses while studying for the exam.

    A Residency and Relocation Loan is designed to help medical and dental students pay for costs while they look for a residency and relocate.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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