How to Choose the Best Private Student Loans
You've already tapped out your federal student loan options, but it's still not enough to cover the cost of tuition.
You're not alone.
Many students go further and look to private student loans to get the financing they need.
According to a recent study done by The College Board1, nearly 11% of students took out non-federal forms of loans (i.e., private loans issued by banks, credit unions, and other lenders) in order to pay for college, during the 2016-2017 school year.
Private student loans are provided by banks and other lenders, with no connection to the federal government whatsoever.
One of the reasons students and their families choose private student loans is because of higher loan limits, but they prove to, at times, have more downsides than other types of loans.
Learn what you should look for before taking out a private student loan.
Private vs. Federal Student Loans
There are several significant differences between private and federal student loans.
Let's cover these differences before you consider applying for either type:
Interest rate and terms
Federal student loans typically only offer fixed rates, where as private student loans offer variable interest rates, which are often several percentage points lower than what you will pay for federal loans.
In addition, private student loans are generally shorter in term, being no more than 15 years. Federal student loans can extend out to 25 years.
Federal Student Loan Interest Rates for 2019-2020
| Loan Type | Fixed Interest Rate | Add-On | Fixed Interest Rate |
|---|---|---|---|
| Direct Subsidized Loans and Direct Unsubsidized Loans for Undergraduate Students | 4.45% | 2.05% | 5.05% |
| Direct Unsubsidized Loans for Graduate and Professional Students | 6.08% | 3.60% | 6.60% |
| Direct PLUS Loans for Parents of Dependent Undergraduate Students and for Graduate or Professional Students | 7.08% | 4.60% | 7.60% |
Loan qualification
Private student loans require you to qualify for the loan, based on income and credit.
For this reason, they usually require a cosigner, typically the student’s parents.
On the other hand, most federal student loan programs have no loan qualifications. A student can take the loans without any income or credit qualifications.
Federal Student Loans
| Loan Name | Description |
|---|---|
| Direct Subsidized Loans | Loans made to eligible undergraduate students who demonstrate financial need to help cover the costs of higher education at a college or career school. |
| Direct Unsubsidized Loans | Loans made to eligible undergraduate, graduate, and professional students, but in this case, the student does not have to demonstrate financial need to be eligible for the loan. |
| Direct PLUS Loans | Loans made to graduate or professional students and parents of dependent undergraduate students to help pay for education expenses not covered by other financial aid. |
| Direct Consolidation Loans | Loan that allows you to combine all of your eligible federal student loans into a single loan with a single loan servicer. |
| Federal Perkins Loan Program | School-based loan program for undergraduates and graduate students with exceptional financial need -- under this program, the school is lender. |
Loan amounts
Federal student loans have certain maximum amounts, whereas private student loans can go as high as $250,000.
If you are an undergraduate student, you are allowed to take out up to $5,500 per year in Perkins loans and between $5,500 and $12,500 per year in Direct Subsidized and/or Unsubsidized Loans.
If you are a graduate student, you are allowed to take out up to $8,000 per year in Perkins loans and up to $20,500 per year in Direct Unsubsidized Loans.
Students often take out private student loans to supplement federal student loans, since they are capped at certain amounts that are, often and unfortunately, not enough to cover the entire cost of tuition.
Examples of Private Student Loan Providers
| Lender | Borrowing Amounts | Available Terms |
|---|---|---|
| Citizen's Bank | $10,000 to $90,000 | 5-, 10-, 15-, and 20-year terms |
| Discover Bank | $5,000 to $150,000 | 10- and 20-year terms |
| CommonBond | $1,000 to $500,000 | 5-, 7-, 10-, 15-, and 20-year terms (Hybrid Rate loans are only available for 10-year terms) |
| Wells Fargo | $5,000 to $120,000 | 5-, 10-, 15-, and 20-year terms |
| SoFi | $5,000 to the amount your schooling costs | 5-, 7-, 10-, 15-, and 20-year terms |
| PNC | $10,000 to $75,000 | 10-, and 15-year terms |
| Earnest | $5,000 to $500,000 | 5-, 10-, 15-, and 20-year terms |
Inability to pay/debt forgiveness
Quite possibly the biggest difference between federal student loans and private student loans are the assistance programs that come with them.
Private student loans have very limited assistance if you are unable to make your payments; they may offer a limited amount of forbearance or require interest-only payments for a time.
Federal student loans have much more elaborate arrangements:
For example, Income Based Repayment (IBRs) Plans limit your monthly payments to no more than 10% of your discretionary income.
Meanwhile, the Public Service Loan Forgiveness (PSLF) Program provides for the forgiveness of your loan balance after you have made 120 qualifying monthly payments. You have to work full-time for a government agency or a nonprofit for at least 10 years.
Pros & Cons of IDR Programs
| Pros | Cons |
|---|---|
Loan origination fees
Federal loans always come with a loan origination fee, typically between 1% and 4% of the loan amount, while many private loans do not.
Simply put, loan origination fees are small percentages of your entire loan, that are tacked on to your loan balance, that you are required to pay in addition to your originally requested loan amount. Think of them as a fee your bank is charging you, for loaning you money in the first place.
These are less common with private loans, and many lenders don’t charge them at all, but make sure to read the fine print, just in case.
Pros and Cons of Private Student Loans
Before applying for private student loans, you should be aware of the pros and cons of the loan type.
Below is a breakdown of several of the most important in each category.
Pros of Private Student Loans
Besides giving you the funds to get an education, private loans come with many benefits:
Higher loan amounts
Many lenders will go well into six figures.
For example, a bank may loan of $150,000 for an undergraduate degree, and $250,000 for a graduate degree.
They may go even higher for a medical or law degree. You can practically borrow as much as you and your cosigner can qualify for.
Lower interest rates
Private loans come with variable rates that can be several decimal points lower than the fixed rates charged on federal loans.
By having a low interest rate, you are lessening the amount of interest you are earning in school, and thus, shortening your entire loan debt.
Dischargeable in bankruptcy
Although very, extremely, incredibly rare, private loans have the ability to be discharged in bankruptcy.
Unfortunately, federal loans do not hold that ability, but they do come with many other perks we mentioned before, like income-driven repayment programs and forgiveness programs.
If you run into severe financial difficulties, and were forced to declare bankruptcy, private student loans have a chance to be totally erased from your debt.
Student Loans in Chapter 7 Bankruptcy vs. Chapter 13 Bankruptcy
| Chapter 7 | Chapter 13 |
|---|---|
| You have little to no income to pay off your debt (and you're able to prove it) | You have a fair amount of income that allows you to pay off some of your debt |
| Most if not all of your debt will be erased and there will be no repayment plan | Your debt is restructured - so a repayment plan will be set up to suit your disposable income |
| Process to absolve debt could take 3 - 5 months | Agreed upon repayment plan could last 3 - 5 years |
Interest-only option
Private student loans often enable you to make monthly payments of interest only while you are in school.
Since interest rates are low, and the initial loan amounts are relatively small, the interest amount is modest.
By making interest-only payments while you are in school, you lower the amount of debt you’ll owe after graduation.
Cons of Private Student Loans
While private loans come with the good, they also bear some negatives that are important to make known:
Variable-rate loans
While these are lower starting rates than fixed-rate loans, the advantage can turn negative if interest rates rise.
One of the most commonly used benchmarks is the London Interbank Offered Rate, otherwise known as the LIBOR index.
You can find out what the LIBOR index might be for your student loan from The Wall Street Journal.
Since variable interest rate loans do exactly what their name says, vary, the rates can increase if general interest rate levels rise, or on the slight chance the LIBOR index goes down, they can decrease.
Fixed-Rate vs. Variable-Rate for Student Loans
| Fixed | Variable |
|---|---|
|
|
You may not qualify
Most students don’t qualify since they don’t have credit or income.
But if your cosigners – usually your parents – don’t qualify, you’ll be ineligible for a private student loan.
Who Should And Shouldn't Cosign On A Student Loan
| People who SHOULD cosign on a student loan: | People who SHOULDN'T cosign on a student loan: |
|---|---|
High loan amounts can be unsustainable
The fact of the matter is because private student loan amounts can go into six figures, you could be saddled with an unsustainable debt burden after graduation.
A loan of $150,000 would be like having a mortgage, but without owning a house to secure it, and if you do not earn the income to maintain your monthly payments, you'll be caught in a tough situation.
Your co-signer's credit will be affected
Both the private student loan and the payment history on it will be included in the credit reports of you and your cosigner.
If you will be expected to make the payments after graduation, any late payments you make will show up on your co-signer's credit report.
Even worse, should you default on the loan, the lender can pursue repayment from your cosigner.
Pros v. Cons of Having A Cosigner On Your Loan
| Pros | Cons |
|---|---|
Refinancing Federal student loans with a private loan
This may be done either to consolidate several loans into one or to get a lower interest rate.
However, by refinancing federal loans into a private loan, you lose the ability to take advantage of modification or debt forgiveness programs, like the IBR and the PSLF.
Refinancing is taking out a private loan that is funded by a bank, to pay for your federal loan, which is funded by the Department of Education, a federal agency.
Key Factors to Look Out for with Private Student Loans
Since there are dozens of different private student loan lenders, there are at least as many variations in the types of loans you can get.
Never assume loan terms from one lender carry across the industry. Each will have their own nuances, and you’ll need to be aware of those.
Some of the more common factors to take into consideration include:
Payment deferral terms
While you’re in school, you’ll need some type of deferral arrangement to make the loan more affordable.
There are three basic types of deferrals offered by private student loan lenders.
1. Full deferral
No payments are made while you’re in school.
The deferral may continue after graduation for several months, but generally limited to no more than six months.
2. Interest only
You pay only the interest on your loan while you’re in school.
As discussed earlier, this has the advantage of lowering the amount of debt you’ll have when you graduate.
3. A reduced monthly payment
The lender may offer you the ability to make a small monthly payment that can include both interest and principal.
Like the interest-only option, it also holds the potential to lower the amount you’ll owe upon graduation.
A lender may offer only one type, or they may offer all three. You should favor a lender that offers a deferral arrangement that will work best for you.
Co-signer release option
Private lenders will often allow you to release your cosigner from the loan.
For that to happen, you must typically make monthly payments from your own resources for between 24 and 48 consecutive months, and those payments must be on time.
The lender will also require you to furnish credit and income information confirming your ability to carry the loan on your own.
How To Choose the Best Private Student Loans
Look, interest rate certainly matters when it comes to borrowing money from any source, but where student loans are concerned, you also have to weigh out the various features and benefits of the available loan types.
You’ll want to favor the loans that will work best in your particular situation. Those may not necessarily be the loans with the lowest interest rate.
Here's the 4 main factors to consider when shopping for a private student loan:
1. Loan term
The longer the loan term, the lower the monthly payment will be.
For this reason, you’ll want to work with lenders who offer the longest possible term.
A bank that offers a 15-year term may be preferred over one that offers a 10-year term, even the longer term includes a higher interest rate.
2. Loan fees
Though private student lenders compete with one another for business, the fee structure each charges can vary significantly.
Loan origination fees are a major cost, and you should favor lenders that don’t charge it.
But also look for application fees, and especially prepayment fees. If you intend to repay the loan early, prepayment fees will be a factor. You should naturally prefer lenders that don’t charge this fee.
3. Loan amount
One lender may loan up to $120,000. Another may go to $250,000.
Most lenders will also offer higher loan amounts for post-graduate education.
You’ll have to determine how much money you’ll need to complete your education. If it will be on the higher end, you’ll need to go with a lender that offers a larger loan amount.
4. Co-signer release
Since you’ll almost certainly need to have a cosigner on your loan, this provision will be a must.
Most private student loan lenders offer the release, but check anyway -- and if it is offered, be sure to get it in writing.
Final Thoughts
As a general rule, you should look first at federal student loans to finance your education.
They are more generous when it comes to deferral arrangements, as well as hardship situations after the fact.
Unfortunately for many students, federal loans just don’t provide a sufficient amount of financing -- and hat’s where private student loans enter the picture.
As you can see, private student loans vary much more than federal student loans.
Be sure to fully investigate all provisions of any private student loan, and choose the one that will work best for you.
1Trends in Student Aid, Figure 4
