Private loans are the fastest-growing sector of the multibillion-dollar student loan industry. Scholarships, grants, and federal student loan options are great ways to help you afford the cost of sending your kids to college, but often they aren’t enough.
Private student loans provided by banks, credit unions, and other lenders can help bridge that gap. According to a recent report by the College Board, Private student loans are used by over one million students each year due to the rising cost of college. Private student loans are also known as alternative education loans.
Private student loans are those student loans other than federal student loans. Private student loans are loans that are disbursed by a bank or other private lender rather than the federal government.
Generally speaking, private student loans should not be considered a substitute, for or an alternative to federal student loans, but an adjunct to them. Private student loans should only be applied for, once you have reached the maximum available federal loans and more financial aid is required.
Unlike federal student loans, the federal government doesn’t guarantee private loans. While guaranteed student loans carry fixed rates, there are no limits on the interest rates and fees banks and other private student loan lenders can charge. Unlike federal loans that are available to all students regardless of credit history, private student loans, like all private loans — be it a car loan or a mortgage — subject the applicant to a credit check. Those with no credit history or a poor credit score can expect to pay higher interest rates for private student loans.
Why the Rise in Popularity of Private Student Loans?
There are several reasons for this increase in private student loan borrowing. The primary reason for the steady increase in private student loans are the limits put on federal loans coupled with rising tuition costs. According to the US Department of Education, if you are an undergraduate student, the maximum amount you can borrow each year in Direct Subsidized Loans and Unsubsidized Direct Loans ranges from $5,500 to $12,500 per year, depending on what year you are in school and your dependency status.
That amount has remained the same since the early 1990s. During that same period of time, the average annual cost of college tuition and room and board at a typical four-year college has risen 135%. Private student loans help bridge these gaps.
Private Student loans have also become increasingly popular options for low-income families as the levels of the most popular Federal Financial Aid programs for low-income families — Pell Grants and Perkins loans — have also failed to keep pace with rising tuition costs.
Private Student Loans Vs. Federal Loans
Private student loans generally cost more than the federal student loan programs and have variable interest rates. Private student loans still have significantly lower interest rates and more generous payback periods than other alternatives such as credit cards.
Unlike federal loans which are open to anybody, private student loans are based on your credit score and or the credit scores of your cosigner if you have one. Generally, credit scores less than 650 will result in a rejected application for a private student loan.
Like most loan products today, private student loans are a big business and a competitive one at that. It pays for the consumer to shop around for the best deal and for the loan product that is right for them. Even for borrowers with good credit, interest rates can vary greatly among top lenders for private student loans. Many private student loan providers charge fees.
The fees charged by some lenders can significantly increase the cost of the loan. Be careful. A loan that looks attractive with a relatively low-interest rate but high fees can actually wind up costing more in the long run than a comparable loan with a higher interest rate and lower or no fees. Most private student loans have an “in school” grace period under which the interest rates are lower.
There are also specialty private student loans available that are used for specific purposes such as:
- To purchase a computer
- To study abroad
- To pay for existing school charges
While many students will need private student loans to cover the cost of college, there are some downsides to consider:
- Generally higher interest rates than federal loans
- Fewer repayment options than federal loans
- Cannot be discharged in bankruptcy
- Credit will be damaged if payments are missed
The bottom line is, private student loans can help offset some of the costs of tuition for your college-bound students, but, like any loan product, should be approached with caution and understanding.