College is more expensive than ever, and most students cover costs with a mix of savings, scholarships and federal student loans from the Department of Education. But what is a private student loan, and how does it fit into this picture?
Private student loans offer a way to cover a gap in funding if you don’t have enough after maxing out your available federal loans. But these private student loans differ from federal ones in major ways, so it’s crucial to understand what you’re getting into before signing on the dotted line.
Here’s what you and your family need to know.
What is a private student loan?
A private student loan is money you borrow from a private lender (such as a bank or credit union) to put toward your education. Most lenders require you to be enrolled at an eligible school to qualify for a loan.
Each lender sets its own criteria, which you’ll have to meet in order to get the loan. Some will let you borrow up to cost of attendance of your school, while others set annual borrowing limits.
If you qualify, many lenders will send the funds directly to your financial aid office to cover your tuition bill. Any remaining money will get sent back to you to use for living expenses or, if you don’t need it, to return to your lender. Note, however, that some lenders will send the funds directly to you instead, meaning it becomes your responsibility to use them for your tuition bill.
When you borrow, you’ll choose repayment terms, typically between five and 15 years. You’ll also likely get to choose between a fixed interest rate, which stays the same over the life of your loan, and a variable rate, which can start lower but might also increase over time.
Each lender could offer different rates and terms, so it’s important to shop around before a private loan to find the best one.
What’s the difference between a private and federal student loan?
As a college or graduate student, you can borrow private student loans from a banking institution, or you can take out federal student loans from the government. Here are the main ways in which private student loans differ from their federal counterparts:
- Private student loans require a credit and income check. While anyone who qualifies for federal aid can borrow federal loans, private loans have stricter requirements. To qualify, you’ll need to meet certain criteria for credit and income — or apply with a cosigner who can.
- You’ll probably need a cosigner. You can borrow federal student loans in your own name, but if you’re an undergraduate, you’ll probably need a cosigner (such as a parent or guardian) to take out a private student loan. Because their name is on your loan, the cosigner becomes just as responsible for repaying the debt as you are.
- Private student loans have less flexible repayment plans. Federal student loans come with a variety of repayment plans, including income-driven repayment, graduated repayment, deferment and forbearance. Private lenders, on the other hand, usually offer plans between five and 20 years, which you select at the time of borrowing. Some lenders will let you postpone payments through forbearance if you lose your job or go back to school, but this isn’t guaranteed.
- You might be considered in default after three missed payments. Federal loans come with a 270-day delinquency period before your loan is considered to be in default, but private lenders might put your loan into default status after just three months of missed bills.
- Private student loans can have a fixed or variable rate. While federal Direct loans to undergraduates have a fixed rate of 5.05% for the 2018-19 school year, private loans can have either a fixed or variable rate — usually, the choice is yours. Rates typically range from around 4% to 13%, depending on your (or your cosigner’s) credit.
- You won’t get your interest subsidized. Students with financial need can qualify for subsidized federal loans, which don’t accrue interest until you graduate and your six-month grace period ends. Private lenders don’t offer subsidized loans, so interest will start piling up as soon as you get the money.
- Private student loans aren’t eligible for federal forgiveness programs. Programs such as Public Service Loan Forgiveness only work for federal loans, not private ones. That said, private loans may be eligible for some loan repayment assistance programs, which could be offered by your state or a private organization.
So if federal student loans have more flexible repayment plans and better interest rates, why borrow private student loans at all? The most common reason is because federal loans come with annual borrowing limits, so you might not have enough funding to pay tuition.
Unless yours is a rare case — for instance, if you’re a graduate student who could get better rates on a private loan and don’t need the federal protections — you’ll want to turn to federal loans first. Unfortunately, however, more than half of students borrow privately before exhausting their federal options.
What are the interest rates on private student loans?
The interest rates on private student loans vary from lender to lender. As of April 2019, some of the most competitive lenders offer fixed rates starting at 3.89% and variable rates starting at 3.00%.
Although this beats the current rate on federal loans, you or your cosigner would be unlikely to score these lowest interest rates unless you have excellent credit. On the other end of the spectrum, fixed rates can go up to 12.68%, and variable rates as high as 12.22% among our recommended lenders.
And don’t forget that these figures do change — in September 2018, rates ran as high as 14.24%. Interest this high could be a real burden for the 15% of graduates who carry private student loans.
As for deciding between fixed and variable rates, remember that the variable rate exposes you to the risk that rates (and possibly your monthly payment) could rise. If you’re confident you can pay your debt off quickly, a variable loan might be worth the risk, while if you’re planning a 10- or 15-year repayment, you might be safer with a fixed loan.
That said, you could always refinance your student loans for new rates and terms if you have the credit to qualify or have a cosigner who can do so.
What about repayment terms?
When you borrow a private student loan, you’ll get to choose your repayment terms. A 10-year plan is standard, but some lenders also let you opt for five, eight or 15 years.
You can use our loan calculator to estimate what your monthly payments would be on each plan. It might be tempting to choose a five-year plan and get out of debt more quickly, but it’s not worth it if you can’t keep up with the higher monthly payments. Meanwhile, on the flip side, a long term with lower monthly payments might appeal to you, but consider how much you’ll have to fork over in interest over the years. The calculator can reveal how much you could expect to pay over time — that said, you can typically prepay your loan without penalty if you suddenly come into some money.
Before you borrow, it’s also crucial to go over your repayment agreement. Some private lenders let you defer repayment while you’re a student and for six months after you graduate, while others require immediate payments or interest-only payments while you’re still in school.
Also make sure you know when your first payment is due so you don’t fall behind or go into default.
Learn what private student loans are before you borrow
Private student loans have both pros and cons for you as a borrower.
On one hand, they can be useful tools for paying for college and earning your degree. But on the other, as a downside, you’ll probably have to enlist a cosigner to qualify, and sharing debt doesn’t always go smoothly.
Plus, you might have relatively high interest rates, meaning you could end up paying back a lot more than you borrowed.
Whatever you decide, make sure you understand what private student loans are before you borrow any. That way, you can make an informed decision about borrowing before it’s too late.
And make sure to compare offers with multiple lenders so you can find one with the best benefits, rates, and terms for your private student loan.