7 key things you need to know about how private student loans work


Note that the student loan situation has changed due to the impact of the coronavirus outbreak and the relief efforts of the government, student loan lenders and others. Check out our Student Loans Hero Coronavirus Information Center for news and additional details.

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Before borrowing a private student loan for college, it’s important to understand how private student loans work. Although these loans provide funding for the school, they have a few key differences from their federal student loan counterparts.

On the one hand, you might need a co-signer to qualify for a private student loan. And secondly, your private student loan will not be eligible for federal repayment plans, protections, or forgiveness programs.

If you’re looking to apply for private student loans, we’ve compiled some important facts to help you decide if private student loans are right for you.

How do private student loans work? 7 key facts

Parents and students can apply for private student loans. Here are seven key things you should know before applying.

1. Private student loans provide additional funding after maximizing federal loans
2. Private student loans are more difficult to qualify that the feds
3. Interest rates and loan terms vary among private student loans
4. Offer of private student loans less flexibility in repayment plans
5. Private college loans in general are not eligible for a loan forgiveness
6. There isfewer options for financial hardship with private loans
7. Private college loans are difficult to release in bankruptcy

1. Private student loans provide additional funding for college after reaching federal loan maximum

Federal student loans, including subsidized direct loans and unsubsidized direct loans, should be your first choice for college funding. They tend to come with low interest rates and flexible repayment terms. Plus, you don’t need to meet credit requirements to borrow most federal student loans.

So before you apply for a private loan, complete your Free Federal Student Assistance Application (FAFSA) – this guide to completing your FAFSA can help – and make sure you exhaust your federal direct loan options first.

However, there is a maximum limit on federal student loans. You could reach your borrowing limit and still need financing for your studies. In this case, it might be wise to consider private loans.

Note that private lenders generally allow you to borrow up to the cost of attending your school, less any other financial assistance (for example, student loans or federal grants) that you have already received.

2. Private student loans are more difficult to obtain than federal student loans.

Almost anyone can qualify for federal student loans, as long as you meet basic eligibility criteria, such as being accepted into an approved program and not in default of student loans.

Private student loans, however, require that you qualify based on your credit score. Private lenders also look at your debt-to-income ratio, which is the number of monthly debt payments compared to your monthly gross income. If you don’t have enough income, private lenders won’t approve a loan.

Since many students have little or no income, and because they often don’t have a credit history, lenders may require students to have a co-signer to qualify for private student loans. . While you can qualify on your own, adding a co-signer to your application could potentially help you get a better interest rate.

3. Interest rates and loan terms vary among private student lenders

When you apply for federal student loans, the interest rate is determined based on the type of loan. This graph shows the current interest rates on federal loans, as of February 3, 2021.

Type of loan Type of borrower School year 2020-21
Directly subsidized First cycle 2.75%
Direct unsubsidized First cycle 2.75%
Direct unsubsidized Graduated / Professional 4.3%
Direct Diploma PLUS Graduated / Professional 5.3%
Direct parent PLUS Parent 5.3%

When you apply for a private student loan, there is no standard interest rate. Instead, different private student loan lenders set their rates. The rates that individual applicants receive vary based on their credit rating, income, and credit history.

On the plus side for private loans, they don’t always include origination fees like federal loans do. Be sure to factor in these fees, charged when you take out the loan, when you compare the cost of the loans.

Private student loans can also have variable interest rates rather than fixed rates. With a variable rate loan, the interest rate is usually influenced by LIBOR or the Fed’s interest rates.

Although variable rates generally start lower than fixed rates, they could increase over time. If your interest rate goes up, your monthly payments and interest costs could go up, which would increase the overall cost of your loan.

4. Private student loans offer less flexibility in repayment plans

When you get federal government college loans, you have many different repayment options, including income-based repayment terms and a standard or graduated repayment schedule. Because you have multiple options, you can choose the repayment plan that’s right for you.

Private student loans generally offer fewer repayment choices and do not offer income-based repayment plans. If you cannot find a job after graduation or if your income is low, you will still have to repay the private loan according to the payment amount agreed upon when you borrowed.

5. Private college loans generally do not qualify for loan forgiveness

Students with federal loans may be eligible for Public Service Loan forgiveness and other federal forgiveness programs if they meet specific work-related conditions and payment history. Students with income-oriented plans may also have their debt balances canceled after 20 to 25 years, depending on the program, although the canceled debt is taxable as income.

Private student loans are not eligible for federal loan forgiveness options. Even if you work your entire career in the public service and your federal loans are canceled, you will likely have to pay off your private loans in full.

That said, there are a few private and public loan repayment assistance programs that will help you pay off private student loans. It’s worth checking out what your state offers to see if you might qualify.

6. There are fewer options for financial hardship with private student loans

If you are having difficulty with your private student loan payments, you have more limited options than with federal student loans.

With federal student loans, you can adjust payments through an income-based repayment plan or suspend them entirely through deferral or forborne.

Private student loans do not qualify for these federal programs, although some private lenders allow you to skip a payment or withhold payments in the event of financial hardship.

These benefits vary by lender, so be sure to research these protections before choosing a loan.

7. Private college loans are hard to pay off in bankruptcy

Although private student loans are not offered or guaranteed by the federal government, they are still treated differently from many other types of consumer debt. As with federal loans, it is very difficult to pay off private student loans in bankruptcy.

Co-signers of private college loans could still be held responsible for repayment even if the student was in extreme hardship to warrant release from bankruptcy.

However, private lenders do not have as much opportunity to collect a delinquent loan as the federal government. While they can sue you for a loan collection, they cannot set off your tax refund or Social Security benefits. In addition, private student loans have a statute of limitations, which varies by state, unlike federal student loans.

How to apply for a private student loan

While private student loans can have serious drawbacks compared to federal student loans, they can be useful if you need additional funding for undergraduate or graduate studies. Just make sure you don’t borrow more than you can afford to repay.

Now that you know how private student loans work, let’s take a look at how to apply for a private student loan. When applying, be sure to research different private student lenders and compare:

  • Eligibility criteria
  • Application fees and origination fees
  • Interest rate and interest rate deductions or discounts available, such as a reduced rate for automated payments
  • Loan terms, including repayment term and prepayment penalties
  • Loan Manager Reviews

You will also need to collect information, including details about your income, tax returns, and information about your financial assets. With this information in hand, you can apply for loans from various banks, credit unions, and other financial institutions.

You can start by looking at our private student loan market to see what types of loans lenders offer. If you think you’ve found the right loan for you, ask for the money you need to cover your school fees, but avoid taking on too much debt.

Rebecca Safier contributed to this report.

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