Turning to a private education loan for help with climbing college costs can be awfully tempting. With an online application and the promise of a low interest rate, a private loan looks so easy and so affordable.
But there’s plenty to be wary about.
Private education loans, also called alternative loans, exist outside of the federal student loan program. With a federal loan, every borrower is guaranteed a fixed, low interest rate and receives the maximum borrower benefits. That’s just not the case with a private loan. Private loans are variable-rate commercial loans that require credit checks. So you’ll need a good credit history or a co-signer to land the low rate you saw online. If you have less-than-stellar credit, you could end up paying a much higher rate, as much as 18 percent, and there’s nothing affordable about that. And because rates on private loans are variable and fluctuate according to market conditions, whatever interest rate you qualify for could change.
The repayment terms on a private education loan vary by lender. With some lenders, repayment begins immediately. Other lenders may allow borrowers to defer loan payments while attending classes.
You also have fewer borrower protections with private loans than you do with more affordable, fixed-rate federal loans such as the Stafford loan.
Federal loans come with a range of borrower protections that are mandated in the federal Higher Education Act. For example, with a federal Stafford loan, every borrower is entitled to deferment due to economic hardship or unemployment for up to three years as long as the borrower meets eligibility requirements for these deferments. Lenders of Stafford loans may also offer forbearance, a temporary postponement of payments, for up to 12 months at a time. Private education loan lenders are not required to offer forbearance or deferment options. Some lenders charge fees to process forbearance and deferment requests of up to $50, and forbearance may only be available for six months.
A private loan is an option to consider after you’ve exhausted your more affordable federal lending options. When borrowing to pay for your college education, put federal loans first and private loans a far, far second. To land a good deal on a private education loan, you’ll need to shop carefully. Rates and fees vary widely. Here are some important questions to ask when shopping for a private loan:
- What are the credit qualifications? All private education loans require a credit check. To get an idea of where you stand before you apply, you can use Credit.com’s free credit report card. Private lenders may consider your credit record, assets, debts, income, as well as your college or university and your field of study. If you have limited or flawed credit, like the majority of students, you may be approved for a loan at a higher interest rate or require a co-signer to qualify for a loan.
- What is the interest rate on the loan and how is the rate calculated? Interest rates on private education loans vary widely, with some lenders charging interest rates between 11 and 18 percent. All private loans come with variable interest rates and may fluctuate due to market conditions. The interest rate on a private education loan is based on a market rate (PRIME or LIBOR or the 91-day Treasury bill) plus a margin. The margin amount, the number of percentage points you pay over and above the market rate, depends on your credit worthiness. If a lender considers you a higher risk, you’ll pay a higher margin and a higher interest rate on your loan. If a lender considers you a lower risk, you’ll pay a lower margin and a lower interest rate on your loan.
- Is there an origination fee? Many lenders charge origination fees on private education loans. Those fees range from 3 to 10 percent of the loan amount. There is no cap on origination fees. So shop carefully. A high origination fee could make a pricey private loan even more expensive.
- When do I begin making payments? Most student loans don’t need to be repaid until after you graduate. But some private loans may ask you to start making payments right away. Can you handle making loan payments while attending classes?
- What is the late fee? Many private lenders charge late fees if your payment arrives 10 or 15 days after the due date. The late fees can be as high as $15 or as much as five percent of the payment amount due.
- Can I defer or reduce loan payments during tough times? Hardship help varies from lender to lender. Does the lender offer deferment due to economic hardship or unemployment? Does the lender offer forbearance, a temporary postponement in payments? Will I be charged a fee? How long will the forbearance period last?
- Will a private loan affect my eligibility for other forms of financial aid? It’s a good idea to have a private loan checked out by a financial aid official at your college or university. The last thing you want is for a private loan to hurt your eligibility for more affordable forms of financial aid.
Weigh your financial options carefully. Federal student loans are the easiest and have the best rates. If you do want to use a private student loan, be sure to get the facts first and only borrow as much as you can eventually afford to repay.