What Are Private Student Loans?

FT Contributor  | 

Private student loans are loans from independent providers that help students pay for the expenses associated with college. They are an alternative to federal student loans, which are originated by the federal government and therefore are subject to the government’s terms.

Below, we’ll explain how private student loans work and the key differences between a private loan and one obtained from the government. Read on to discover if private loans are right for you.

Private Student Loan Interest Rates

Unlike federal student loans, which have a fixed interest rate, private student loan rates are variable. This means they can fluctuate throughout the term of your loan, resulting in a more expensive price tag. Additionally, private loans often have a higher interest rate on average. Note that private loans are not subject to interest rate caps.

Furthermore, private loans aren’t subsidized, which means interest starts to accrue as soon as the loan is paid out to you. Depending on the lender, many factors can impact what your loan interest rates are, such as the term of the loan, the amount, and your credit score.

Private Student Loans and Bad Credit

Poor credit generally equates to worse interest rates. However, there are still ways for a student with bad credit to get a reasonable interest rate. For example, look into federal student loans instead. These government-controlled loans have federally mandated caps and do not take your credit score into account during the lending process. Additionally, some federal loans are subsidized, which means you don’t have to pay for interest while you attend school.

You may be able to lower the interest rate of your private loan if you enroll for automatic payments or consolidate your loans. It all depends on the lender.

Private vs Federal Student Loans

As stated above, private loans are provided through independent lenders, while federal loans are provided by the government. Federal loans may be subsidized or unsubsidized, which can drastically impact what you owe in interest. Private loans are never subsidized. Below, we’ll explain the difference between private loans and federal student loans and the pros and cons of each.

Benefits of Private Student Loans

Unlike federal student loans, private student loans don’t have borrowing limits. Additionally, eligibility for a private loan is not determined by financial need. If you have good credit, private loans are an excellent substitute for any funds missing from scholarships or federal loans.

While private loans are known for their high interest rates, it may be possible (although not a guarantee) to qualify for a private student loan at a lower interest rate than federal loans. If you have a high credit score, you’re more likely to receive a better interest rate.

What Is the Advantage of Federal Loans Over Private Loans?

While federal loans have more restrictions and are more difficult to obtain, they do tend to have better interest rates. Since 2013, federal student loan interest rates have been set each year based on the 10-year Treasury note rate. Another benefit of federal loans is the more forgiving repayment options. Unlike private loans, federal loans can be forgiven in some cases and are eligible for certain repayment assistance programs.

Should I Get a Private Student Loan?

Private student loans lack a lot of the advantages that federal student loans have. As mentioned previously, the interest rates on private loans are often variable and can increase at any time. Interest starts accruing right away, as private loans aren’t subsidized. Additionally, private loans are less flexible and ineligible for loan forgiveness or income-driven payments. Some private loans require you to make payments during your time in school.

However, for those who have reached their borrowing limits on federal loans, are otherwise ineligible, or who can get very good interest rates through private loans, private student loans can be a viable option.

How to Get a Private Student Loan

Unlike federal loans, which require you to fill out the Free Application for Federal Student Aid (FAFSA), private loans require you to apply directly with the lender. Below you’ll find tips and tricks for finding the best private loan possible.

  1. Conduct research: Look into reputable financial institutions, such as your bank or Sallie Mae, to see what their private loan requirements are. Compare factors like interest rates, payment terms, and fees to find the most cost-effective loan.
  2. Apply at the right time: Private loans don’t have an application deadline, which may be helpful in the event that your federal loans run out. With that said, you shouldn’t wait until the last minute to apply for a private loan. The application process can take as long as two months, so leave yourself some wiggle room.
  3. Enlist a cosigner: If your credit isn’t all that great, having a cosigner can help you get better interest rates on your private loan.
  4. Determine your loan amount: Analyze your FAFSA response to determine your schooling costs. This will help you identify gaps in your federal loans and apply for the right private loan amount.
  5. Submit a formal application: This process will vary depending on the lender, but having all of your paperwork filled out accurately will help expedite the application process.

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This post was updated November 25, 2019. It was originally published November 25, 2019.