Should I Take Out Private Student Loans?
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As we’ve previously discussed in our post Borrowing for Beginners: An Introduction to Student Loans, student loans are an option that many students and their families turn to for help in financing a college education. They may not reduce the cost of college, but they do allow you to spread it out over time, which can often make the expense more manageable.
Student loans come in two major varieties: federal government loans and private loans. Federal loans are provided and administered by the U.S. Department of Education. Private student loans, on the other hand, are provided and administered by private lenders, who set their own policies and terms.
Private student loans are popular and well-advertised, and many students are potentially interested in them. However, they’re not the best choice for everyone. If you’re considering taking on this very serious financial commitment, you’ll first need to make sure you thoroughly understand what you’re agreeing to.
Read on to learn more about what it means to take out a private student loan, the risks that come with these loans, and how to figure out if private student loans are a wise option for you.
What are private student loans?
The basic definition of a private student loan is any loan intended for educational expenses that is provided by a lender who isn’t the federal government. The banks you use on a daily basis can sometimes be lenders, as can businesses (like the well-known company Sallie Mae), which exist primarily to deal in student loans. Many different options exist, and you can choose which to apply to if it comes time for you to solicit a loan.
One way to tell whether a student loan is private is whether you see it advertised on TV, in signage, or anywhere else. The U.S. Department of Education is prohibited from advertising its federal student loans, so any advertised loan is necessarily a private loan.
The defining feature of student loans, whether they’re federal or private, is that eventually you’ll have to pay them back. When you do so, you’ll also pay interest, an additional sum based on how much you borrow and for how long. Due to interest, the total amount you pay back will be larger than the amount you borrowed — sometimes significantly so.
The need to repay your student loans makes them a less attractive option for paying for your education than, for example, grants and scholarships that you aren’t required to pay back. Within the world of student loans, federal loans tend to offer better terms for most students than private loans. However, in certain situations, private loans may still be an attractive option for students and their families looking for financial solutions.
Why do some students seek out private student loans?
If you’re planning for college, you already know that getting your degree is an expensive prospect. The direct and indirect costs of attending college are getting higher all the time, especially at top-tier schools, where an average student might easily incur well over $50,000 in expenses per year.
Obviously, educational costs like these are out of reach for many students and their families. Financial aid can help, but not every student can access substantial grant aid — the complex application process for need-based aid can be an obstacle, and competition for merit-based scholarships is often fierce.
Student loans provide another option for students and families who are looking for ways to make college financially possible. By spreading out your payments, and possibly also delaying them until you have a full-time, post-college income, they can help you to reap the benefits of a college education in a way that fits into your budget.
As we’ve mentioned, federal student loans generally have more borrower-friendly terms than private student loans. However, they also have limitations. There are eligibility restrictions, and access to certain federal loan options is determined by your financial need. There are also limits on how much you can borrow each year and overall, meaning that federal loans may not be able to entirely bridge the gap between your resources and your college costs.
The financial situations of real-life students and families are complicated, sometimes extremely so, and standard financial aid forms like the FAFSA don’t always adequately reflect their complexities. Your ability to pay for college in real life might not match up how your finances look on paper, resulting in you receiving less financial aid from other sources than you actually need to attend college.
In addition, some students and families have special circumstances in place that make taking out private student loans a wiser choice. If you’re expecting to receive a large inheritance soon, for example, or if you have a relative who is willing to act as a cosigner and help you pay off your debt, private loans might be a particularly attractive option for you. (Check out our blog post An Introduction to Financial Aid for Complex Families to learn more about what situations might complicate your financial aid.)
If, for whatever reason, paying for college is beyond your means, but you’re not able to access sufficient federal loan funding or other forms of financial aid, private student loans can offer another financing path. This can offer flexibility for you and your parents in figuring out how to make it possible for you to attend college.
As we’ll discuss below, there are also downsides to taking out private student loans, and they’re not the best choice for everyone. However, it remains true that a good college education is a major asset that can significantly shape your future plans and options. You may decide that these downsides are worth the opportunities your education will provide.
What are the downsides of taking out private student loans?
The major downside of private student loans is they generally aren’t as favorable a deal for you, the borrower, as federal student loans. Federal loans are subject to a larger number of regulations and are more uniform in nature. They are, in some sense, a public service, so they’re built to be more accessible to a larger number of people. Some are even subsidized, meaning that you won’t accumulate interest while you’re still in school.
Private student loans are offered by private lenders who are operating for-profit lending businesses. These loans are less standardized, less predictable, and often less favorable to you than federal loans in their terms, requirements, and application procedures.
For example, federal student loans don’t require a credit check or base the details of your loan upon your credit. Private loans, on the other hand, do. Since most high school and college students haven’t built up a good credit history, they’ll usually need a cosigner — someone with a better credit background who agrees to be responsible for the loan should the main borrower be unable to pay. Finding someone who can (and is willing to) fill this role may be difficult.
Credit checks for private student loans can also be used to determine important details, such as your loan’s interest rate. In contrast with federal loans, which have a set interest rate that’s used for everyone, private loan interest rates can vary from person to person and loan to loan. You might even be turned down entirely when you apply for a loan.
Private loans frequently come with a variable interest rate, meaning that your interest rate may either rise or fall in the future based upon market conditions. This in turn means that the total amount you’ll repay to your lender isn’t entirely predictable, and may end up being higher than you expected.
Another major downside of private student loans is that in comparison to federal loans, private loans generally provide less flexibility during the repayment process. Instead of having a grace period between when you graduate and when you start repaying your loans, you’ll often have to start repayment as soon as you leave school. In some cases, you might even have to start making payments on the loan immediately upon receiving your loan funds.
Private student loans often don’t provide repayment plan options like income-based repayment or graduated repayment, which can be helpful to new college graduates getting started on their careers. They may also offer fewer options when it comes to delaying repayment due to special circumstances, and they aren’t part of loan forgiveness programs in which your loan can be cancelled if you work in certain public-service fields.
What should I do before choosing whether to take out a private student loan?
As you can see, private student loans can be helpful, but they involve significant risks, and taking out a private loan is not a decision to be made lightly. Here’s what to do if you’re considering taking out a private loan to finance your college education.
- First of all, carefully review your financial aid award letter. Make sure you understand your total cost of attendance, what other aid you’ll be receiving, and what this aid covers. If your award doesn’t fit your needs, consider filing an appeal. (Take a look at our post Can I Appeal My Financial Aid Award? for details on how to do so.)
- Talk to your family members and get a full picture of your financial situation. Before you consider a private loan, think about what other resources you might be able to access, such as help from a family member or the sale of an asset.
- Talk to your financial aid officer(s) about your financing options. They may have additional information or suggestions for resources you haven’t considered.
- Exhaust all other sources of financial assistance. These might include need-based grants, merit-based scholarships, family assistance, and/or federal student loans. Don’t jump to private student loans right away — use your other options first.
- Find a cosigner. Most likely, your own credit history won’t be sufficient to get you a private student loan, so someone else will have to cosign it; parents often do so, but another adult can fill the role as well if they’re willing. This is a major favor to ask of someone, and they’ll really have to trust you if they’re to take that risk, so start thinking about it in advance.
- Understand all the terms and details of the loan. Know your interest rate and whether it’s variable. Get an estimate of your future monthly payments and the overall amount you’ll pay back. Take a look at what options you might have if, at some point in your life, you’re unable to make payments.
- Consider your future ability to pay. What are the job and income prospects for your intended career path? What kind of monthly payments might you be able to handle? You can’t always predict these figures, but getting a rough idea of your future potential resources will help you to decide whether you’ll actually be able to repay the loan.
Finally, before you take out any student loan, whether it’s a federal loan or a private loan, you need to make sure you understand that going into debt for your education represents a very serious commitment. The money you borrow to help pay for college may not seem “real” right now, but it very much is, and hastily made decisions now can lead to serious consequences for your future self.
Failing to pay back your student loans according to schedule can lead to serious consequences, from causing your income to be garnished to severely impacting your credit score. Student loans can’t be discharged even by bankruptcy, so whatever else happens in your life, these loans will continue to affect you for many years.
Whatever you do, make sure that you research your options thoroughly and make as thoughtful and informed a decision as you possibly can. Private student loans can bridge a funding gap and make it possible for you to access the educational opportunities you’ve dreamed about, but they’re not without their risks. You’ll need to decide whether your personal risk/benefit analysis makes taking out private student loans to supplement your other aid a wise decision.
For More Information
Figuring out how to pay for your education may not be the most fun part of getting ready for college, but it’s a very necessary consideration, and one that may have a significant impact upon where you eventually end up. Here are some other posts from the CollegeVine blog that may be of interest as you navigate the world of college costs and financial aid.
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