The world of college planning may seem like a whirlwind of information to sort through. Many families become stressed thinking about all the decisions involved, especially when it comes to paying for college and figuring out how to make it more affordable.
Some families accept government loans to help pay for college, while others look into private loans to help cover their costs. Private loans may be a good fit for your family if the conditions and rates are in your favor.
In this article, I’ll give the details of private loans, so you can decide if they may work for you. Knowing your available options and how they work will help you to plan accordingly and reduce stress.
Let’s jump right in and introduce some of the basics about private loans.
What is a Private Student Loan?
- A private student loan is a loan from a bank, credit union, or a student loan provider.
- The loans are available at most two and four-year colleges.
- This loan is underwritten based on the credit worthiness of the parents or other cosigner.
- The maximum amount that can be borrowed is the lower of the following two scenarios:
- The first is the total cost of attendance for the college you’re considering, minus any other aid and loans a student receives. You can’t borrow more than the costs at your college.
- The second scenario is when the bank determines how much a particular family can afford to borrow. This can limit the amount some families may borrow based on underwriting.
- Interest rates vary between very good and very bad depending on the credit worthiness of the cosigner. People with stellar credit may get better rates with private loans than with federal loans.
- Many parents use this loan because the student can be the primary borrower. It makes it clear that the student is responsible to repay, but the parents are still on the hook if the student defaults.
- Many families that take this loan would be better off with a Parent PLUS Loan.
- Some private loans allow for payment deferral until graduation, but they do not participate in federal repayment plans.
Now that you have a basic understanding of private loans, let’s discuss the 9 things you should know about them.
1. Private loans can be stacked on top of Direct Student Loans.
Direct Loans are generally the first for most students and families because the interest rates are better than they are with other loans—even if parents plan to pay off the student’s loans.
A private student loan can then be stacked on top of the Direct Student Loan to make up the difference in the total that is needed for all of your college expenses.
2. Interest rates
Private loan rates can be fixed or variable, and the rate that is offered depends on the credit worthiness of the parents or other cosigner.
Parents with marginal and poor credit may be able to get better rates with a PLUS Loan.
Table A shows sample interest rates for a major, private provider and a smaller credit union. These rates can be compared to the rate for a Parent PLUS Loan in the last column.
|Major Lender # 1||Smaller Credit Union||Parent PLUS Loans|
|Variable 3.12% – 11.62%||Variable 4.69% – 11.44%||Variable N/A|
|Fixed 4.74% – 12.49%||Fixed 6.29% – 12.04%||Fixed 7.08%|
It’s important to know that some lenders offer teaser rates that few families actually receive after underwriting.
For example, when a lender advertises rates between 4% to 10%, nearly all families will probably get a rate of 6% to 10%. Only a rare handful will receive the 4%.
3. Private student loan benefits
Variable interest rate loans can be helpful since your rate may be lower in the long run.
Private loans can be structured in the student’s name, which makes it clear who is responsible for the loan.
Death and disability benefits are offered with some private loans.
However, the benefits you receive will largely depend on the provider you select. Below are two examples of different benefits a provider might offer.
Example 1 – Some lenders offer a multi-year loan, which is beneficial because you can lock in a rate for a period of time. In this case, the lender may approve you for a larger number than what is needed for one year, and then you have access to that amount over the next few years.
As an example, you may get approved to borrow $75,000 and then use $25,000 over each of the next three years.
Example 2 – Some lenders may offer the ability to have the cosigner removed from the loan after the borrower makes a predetermined amount of payments on time.
When you’re looking for a private loan, make certain to shop around and carefully review all the details of each loan to compare your options. Don’t forget to read all the fine print and be familiar with the loan that you select.
Table B compares the benefits of a typical major, private lender and a smaller credit union
|Major Lender||Credit Union|
Multi-year borrowing option
Co-signer may be released after a fixed amount of prompt payments.
Good grades and graduation rewards
Loan specialist on call for consultation
Financial seminars and budget counseling
4. Private student loan drawbacks
Most of the terms and conditions of private loans are governed by the loan agreement, and every lender has its own terms and conditions.
Often you can’t get a copy of an agreement until after you’ve applied, which can make it challenging to compare loans from multiple sources.
Many lenders have teaser rates on their websites. Most people don’t get the top rates that are advertised since you must have very strong credit to receive those top rates.
Any late payments will show up on the student and parent’s credit.
Unlike federal loans, there’s usually not a contingency plan in the event of a college failing and ceasing to operate.
Private loans are not part of any federal consolidation and repayment programs.
Lastly, you’ll have to deal with the tedious task of reading all the fine print pertaining to the loan.
5. Process for receiving the loan
First, it will help to know that private loans are finalized after your student’s graduation or during their senior year of high school. Choosing your loans and doing the paperwork happens right before you take your kids to college.
If you understand the process early in your student’s high school years, you can plan accordingly when they get to their senior year.
Second, it’s useful to shop around during the senior year of high school and compare plans, rates, and conditions for loans you’re considering applying for.
Make certain to check with the lenders to confirm that they have a lending relationship with the school your student will be attending.
Next, you’ll follow whatever procedure the lender requires in order to apply for their loan. The application could be online, or they may take your information over the phone. This application process usually takes place in the spring of senior year.
Students are usually required to provide the lender with documentation of their enrollment status. You’ll have this once your student commits to a school and makes a tuition deposit, usually by May 1.
The lender will then complete a credit check and notify you about your eligibility and the specifics of the loan. You’ll work directly with the lender for the process, not the financial aid office of the college.
Lastly, you’ll sign loan documents electronically and accept loan terms, and the money will be sent either directly to the college or to the parent or student.
6. Receiving the money
Private student loan money is sent either directly to the college or to the parent or student.
If the money is sent directly to the college, the lender will disburse the money in one of three ways:
- Apply one-half of the funds to each semester
- Apply one-third of the funds to each trimester
- Send one large check paid to the school up-front.
If there is money left over after applying the loan to your student’s bills at the college, you must tell the school what to do with the extra money.
Parents may either request to receive the extra money themselves, or they can have the money disbursed to the student to help them pay for other expenses such as books and rent.
7. How you’ll make your payments
Repayment is based on the original terms of the loan. Below are some key point you’ll want to know about repayment:
- Sometimes payments begin shortly after the loan is dispersed. Other times, payments can be deferred until after the student graduates or drops below part-time enrollment. Deferment is helpful since it gives the student some time to get on their feet with their career before making payments.
- Interest almost always accrues even if payments are deferred.
- Some plans may allow you to make interest-only payments while in school, or to pay a fixed amount towards your interest while in school to help lower your total cost.
- Most loans will allow you to make payments at any time to help with lowering your cost.
- Loans can be refinanced to help reduce monthly payments.
Table C compares the components of payment plans for a typical major, private lender and a smaller credit union.
|Repayment Plan Components||Major Lender||Smaller Credit Union|
|Payment start time||6 months after graduation||6 months after graduation|
|Payment options||In-school interest-only and In-school fixed||Interest-only for the first 2 years of repayment|
|Payment time frame||15 years||15 years|
While the Parent PLUS Loan has a fee of 4.26%, many private loans don’t have fees. The cost for a private loan is based on the interest rate alone.
You’ll want to watch out for hidden costs with private loans such as late payment fees, changes in interest rates, and other penalties if you fall behind with payments.
Once again, it’s important to read all the fine print for your loan.
Some private loans may list rewards such as good grade rewards, graduation rewards, and automatic debit rewards.
These rewards may be legitimate benefits, or they can be more of a gimmick to help make a loan seem more appealing despite having a high interest rate. You may be better off taking another loan with better rates and without gimmicks.
The following explains rewards that are offered by some lenders:
Good grade rewards. These rewards offer a small percentage of the loan amount if the student maintains a certain GPA, usually around 3.0. This is often a one-time reward.
Graduation rewards. These rewards offer a small percentage of the principle balance at graduation when you obtain your degree.
Automatic Debit Reward. This will reduce your interest by a very small percentage if you enroll your payments to auto pay. The reduction is often as low as 0.25%.
To redeem these rewards, lenders provide phone numbers to call, or you’ll log into your account to provide documentation of your GPA, confirm that you have received your degree, or enroll in auto pay.
Remember that these rewards could be gimmicks to make a loan seem appealing despite a high interest rate.
You should ask yourself the following questions to decide if the rewards would be worthwhile.
- Do you understand all of the rules? If you fail to follow all of the rules, you may not qualify for the reward.
- Will you be able to claim your reward by the date provided? Many of these rewards need to be redeemed by specific dates.
- Do you have to be perfect to receive the reward? For example, if your GPA drops to 2.8 for one semester only, will you still qualify for the good grade reward?
- Will you follow through and do what’s necessary to receive the reward? Rewards are frequently offered with the lender knowing that many people will never claim them.
What should you do now?
Hopefully you’ve gained a better understanding about private student loans, and hopefully this will help you decide if you should look further into them as an option.
The more you know, the more relieved you’ll feel as you continue on your college journey.
If you have any further questions, feel free to leave a comment below or contact me now.
You can also find other helpful college planning articles and resources by checking out the following links and recommendations:
Want More Help with College Planning?
Subscribe to my free e-newsletter and get great tips and advice on how to plan and save more money for college, how to reduce your costs, and how to put your student on the path to a bright future. You can also check some of my other helpful blog articles and resources below.