Private student loans can fill the gap between financial aid and the cost of attending school. When you’ve exhausted all forms of aid such as grants, scholarships, and federal student loans, private loans can be a low-cost alternative to pay for school.
But before accepting private loans, understand these pros and cons.
Private Student Loans versus Federal Loans
There are two types of student loans–federal student loans that are issued by the US Department of Education and private student loans offered by financial institutions.
If you must take out student loans, federal student loans are the best option for the vast majority of borrowers. It is best to max out your federal student loan options before you borrow any private student loans.
With federal loans, you must complete the FAFSA to qualify. To get private student loans, you must apply with a private lender such as a bank, credit union or financing company.
Federal student loans have strict limits with dependent undergrads borrowing up to $31,000 and independent undergrads borrowing up to $57,500 with graduate student borrowing limits up to $138,500. A credit report is not required to receive federal student loans. Federal student loans usually carry more flexible protection if you run into difficulty in repaying your loans, and all new federal student loans have fixed interest rates, meaning the rate does not change over the life of your loan.
On the other hand, private student loan limits are set by the bank, credit union or financing company. Private lenders may cap the amount of the loan based on the total cost of attendance minus any financial aid received. Private student loans generally have variable interest rates, which can reset every month or quarter, causing your monthly payments to change. However, fixed-rate loans are becoming more readily available.
Pros and Cons of Private Student Loans
All federal student loan interest paid and most private student loan interest paid may have tax benefits. However, there are rare cases where a private loan could be a viable alternative to a federal loan. This may occur if you:
- Are a graduate or professional school student with a high certainty of job placement
- Have a very good credit score
- Can borrow at interest rates lower than current federal loan rates
- Are completely committed to finishing the degree program on time
- Have a specific plan to repay your loans within a few years of graduation
- Have already borrowed as much as you can under the Direct Loan programs
If you have all of the above characteristics, you may want to consider private student loans too.
Your situation may be different, so consult with your school’s financial aid office for additional information and shop around with private student lenders to compare.
Advantages of Private Student Loans
Private loans offer a few advantages compared to federal loans.
Fills the financing gap
With federal loans, there’s a limit in how much you can borrow each academic school year. For example, a dependent undergrad student can borrow no more than $5,500 in federally subsidized loans per year. However, this may not be enough to cover the cost of attending. Private loans, however, have larger limits that are set by private lenders.
Flexible borrowing options
Private student loans are not needs-based. If you can meet the criteria set by the private lender, you’ll get approved for the loan. Additionally, private loans offer both fixed and variable rates offering more choices to lessen the total cost of borrowing.
In some instances, rates from a private lender may be lower. The US Congress sets the interest rates for student loans each year which is fixed until repaid. Private lenders compete for your business and use creditworthiness to determine rates which can mean a lower rate.
Disadvantages of Private Student Loans
Private loans do come with some downsides. Before accepting the loan consider the following:
You’ll need good credit in order to qualify. Having no credit or less than good credit may mean higher loan rates too or denial. For many dependent undergraduates, a cosigner is needed to get approved. The cosigner’s creditworthiness will be used in the approval process.
A variable interest rate may mean a lower rate today but it can also mean higher rates tomorrow.
Federal student loans have amazing benefits such as income-driven repayment plans and loan forgiveness. With private loans, lenders may offer forbearance for borrowers experiencing financial hardships, but do not offer forgiveness or lower payment options. To lower monthly payments, refinancing student loans may only be the option available.
Private Student Loan FAQs
Should I take out private student loans?
There are benefits to private loans when financial aid isn’t enough to cover the total cost of attending school. Start with exhausting all your federal student loan options first before considering private loans. The first step is to complete the FAFSA to determine how much financial aid you qualify for.
Where can I find private student loans?
Private student loans are offered by private lenders such as banks, credit unions, and other financing companies. You must complete a loan application with each lender to start the process. However, many student loan marketplaces allow you to check your rate with multiple lenders before applying. Use a marketplace and check your rates.
When do I repay private loans?
The repayment of your private student loans depends on the terms you’ve agreed to. Some private lenders have in-school forbearance where interest accrues but no payments are required until after leaving school. Other private loans may require immediate payment while in school.
Can I refinance private loans?
Yes, private loans can be refinanced. You can refinance one or multiple loans together to lock in a better rate and new terms. In some instances, refinancing both private and federal student loans may save you thousands of dollars.
Are all private loans the same?
No. Private lenders decide on the rates, terms, and benefits of their private student loans. When considering private loans, do research, ask questions, and decide on which loan is best for you. Compare the options available before signing on the dotted line.
How can I pay off my private student loans?
Contact your private lender for the payoff amount. Most private loans do not have prepayment penalties which are fees for paying off loans before the terms are due. Learn how to request a student loan payoff letter.