Private Student Loans 101: A Beginner’s Guide

Key Takeaways:

  • Interest rates for private loans can be fixed or variable.
  • Well-qualified borrowers could find lower interest rates with private student loans, but many may find that federal loans have lower rates.
  • You can add a cosigner to your private loan if you need help qualifying.
  • Private loans usually have higher borrowing amounts than other types of education debt.
  • You can refinance your debt with a private loan, which may make sense if you can get a better interest rate than your old loan.

Though it’s often recommended to use federal student loans before applying with other lenders, private student loans can have an important place in your financial plan. Whether federal loans don’t cover all your college costs or you’re lucky enough to lock in a stellar interest rate with a private lender, here’s everything you need to know about private student loans. 

What Are Private Student Loans? 

While federal student loans are funded by the U.S. government, private student loans are funded by institutions such as banks, credit unions, and online lenders. The amount you borrow can be used to pay for things like tuition, housing, and other costs related to school. 

Though exact eligibility requirements vary from lender to lender, you’ll usually need to be enrolled in an eligible school, fulfill credit and income standards, and meet other education and citizenship requirements. If you don’t qualify on your own, you can usually add a cosigner to the loan. Some private lenders even offer education loans to parents of college students.

Before you borrow a private loan, it’s a good idea to do some comparison shopping and see which lenders might offer you the most favorable terms. Then, you’ll need to submit an application to each lender you’re interested in before accepting the final terms. 

How Much Can I Borrow? 

One of the perks of private loans is you can often borrow more than you could with federal loans. This can be useful if federal loans don’t cover the entire cost of your education. 

The amount you’re allowed to borrow is typically based on several factors, including your financial information, how much your school costs, and how much the lender thinks you can reasonably repay. Many lenders verify the cost of attendance at your school and will lend you up to that amount. Other lenders put an annual cap on how much you can borrow, which can range from about $50,000 to $150,000 or more per year. 

Each lender sets different rules about how much you can borrow, so before you apply make sure you can borrow the amount you need.

What Are Interest Rates Like on Private Loans? 

While federal loans only offer fixed interest rates, rates on private student loans can be fixed or variable. Fixed rates remain the same over the life of the loan, while variable rates can change based on certain market indicators. 

One isn’t necessarily better than the other; which is best for you depends on your repayment strategy and your risk tolerance. Fixed rates are usually higher, but since you lock in a rate at the start of your loan, you know exactly how much interest you will pay. In contrast, you’ll likely be able to snag a lower variable rate, but it could go up or down with little warning in the future. 

Variable rates can change several times a year, so if it trends upwards you may pay more interest than you originally planned. However, if you intend to pay off your loans quickly (in five years or less, for example), your interest rate will have less time to increase and your risk may be lower.

No matter which type of rate you choose, the interest rate you qualify for will be based on your creditworthiness, income, and other factors. If you have great credit, you can qualify for better rates than someone with poor credit. Though the exact terms you’re offered will vary by lender, rates in 2020 usually range from about 2-3 percent up to 13 percent or more. 

This is in contrast to federal loan rates, which are the cheaper option for many borrowers. Federal interest rates in 2020 are 2.75 to 5.30 percent, and the rates you qualify for aren’t based on your credit for most federal loan types. This means even poor-credit borrowers can get an affordable rate. 

However, if you have excellent credit (or a cosigner with stellar credit), you might find private loan rates that are lower than the current federal loan options. 

How Do I Repay Private Loans?

Like everything else, the exact repayment plans you qualify for varies by lender. However, many private lenders allow you to choose when you start repayment. You can often choose to make full payments right away, make interest-only payments while in school, or defer all payments until six months after you graduate. 

Once you start repayment, you’ll be expected to pay off your debt completely by the end of the loan’s repayment period — which you selected when you first took out the debt. Repayment periods are commonly 10 years but can be as short as five or as long as 15 or more. Shorter repayment terms usually come with lower interest rates. 

And while federal loans are known for their flexible repayment options, you probably won’t find a private lender who can match them. Some private loans allow you to temporarily pause payments if you run into financial trouble, but that’s all the help you’re likely to get. If you’re struggling to make your payments with a private lender, you could negotiate with them to lower your interest rate or extend your repayment period — but that’s entirely at the lender’s discretion and is by no means guaranteed. 

How Does Refinancing Work?

If you already have a student loan and aren’t thrilled with the terms, you’re not stuck with it forever. You can refinance the loan with another lender that offers better rates. Essentially, you take out a new private loan for the same amount as your old debt, then use the newly borrowed money to repay your old loan. 

This can be a savvy move if your credit has significantly improved or if current interest rates are lower than they were when you took out the old debt. Refinancing can also be useful if you have trouble keeping track of several student loans; you can combine them all into one refinanced loan, which would give you only one monthly payment to worry about. 

Both federal and private student loans can be refinanced, but beware: If you refinance federal loans they become private debt, and you will no longer be eligible for federal benefits such as flexible repayment plans or loan forgiveness

Pros and Cons of Private Student Loans

Though private student loans are certainly useful, they come with a lot of factors to consider. Check out the pros and cons of private debt before submitting your application. 

Pros

Cons

Borrowers with excellent credit could qualify for lower rates than federal loans 

Must have good credit to be eligible

Higher borrowing limits can help you afford the education costs that federal loans don’t cover

Don’t come with the same protections as federal student loans

Variable rates may be preferable for some borrowers

A cosigner may be required, especially for younger borrowers

Usually a simpler application process

No options for subsidized interest



When Is a Private Loan Worth It?

While a private loan may have a place in your plan to pay for college, for most borrowers it likely makes sense to max out federal loans before opting for private debt. Unless you have excellent credit, high income, and other desirable factors, a private loan may cost you more in the long run — and if you struggle to repay the loan later, you’ll have fewer options to get help. 

But federal student loans may not cover all your education expenses, which is where private loans come in handy. Before you take out this type of debt, make sure to review your options, compare rates among private lenders, and create a plan to repay the debt later.

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