This is What You Need to Know Before You Take Out a Private Student Loan

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Do a quick search for information about student loans, and you’ll find myriad sites offering comprehensive guides… about federal student loans.

This information is great, of course, because millions of undergrads and grad students borrow student loans from the federal government.

But what about the students who rely on private loans to pay for school? That number reached 1.4 million in 2012-13

Of the $1.4 trillion in outstanding student loan debt, private loans represent about 8% of that total, or $108.2 billion. 

Private loans represented 10% of the $107 billion in loans taken out by students in the 2015-2016 academic year, according to the latest numbers from The College Board.

The abundance of information about federal loans can be confusing for borrowers who need more than what the Department of Education has to offer.

We decided to untangle the information for you — whether you’re considering borrowing private loans yourself or you just want to know what the heck all this talk about Sallie Mae is about.

Your First Step

To start, before you look into private loans, your first step should always be to fill out a FAFSA to see what you can get through federal grants and loans.

This will show you which grants (free money!) you’re eligible for and whether you’re eligible for work study programs (money you work for, instead of paying back) — two options you don’t have with private lenders.

Federal loans also often come with flexibility that could come in handy in the future, like deferment, income-based repayment and loan forgiveness. These are harder to come by with private loans.

Why Apply for a Private Student Loan?

“I often tell people even if the interest rate’s a little bit lower on the private loans, you might still go with the federal loan,” explains Kevin Walker, VP and Head of Education Loans at LendingTree.

With federal loans, he says, “you have flexibility for deferment, forbearance, income-based repayment. There’s a lot of conditions on federal loans that private loans don’t have.”

With that giant caveat, why should a student even look at private loans? Walker explains two common scenarios.

1. Your Federal Loans aren’t Enough

The traditional reason to apply for private student loans is you simply aren’t eligible for enough in federal loans, grants or work study to cover your college costs.

In your financial aid award notice from schools, you’ll see how much federal aid you’re eligible to receive. If that won’t cover your tuition and other costs, you could consider private loans to fill the gaps.

2. You Can Get a Lower Interest Rate

Increasingly, Walker says, students and parents are able to get a lower interest rate on private loans than federal ones.

This is most often true, he says, of parent PLUS loans, a federal supplemental loan in your parent’s name.

“So there might be some occasions where a student would borrow a private loan or a parent would borrow a private loan instead of a federal loan,” he said.

PLUS loans for parents and grad students tend to have much higher interest rates than other federal loans. So if you or your parents have a strong credit score, a private loan could be a better deal.

To see what kind of interest rate you’d qualify for — to compare with your federal loan options — you can enter your information into a student loan marketplace like Credible.

It’s free, and you don’t have to make any commitment to find your rates. Credible will just show you what you might qualify for from several lenders, so you can pick what works best for you.

Why NOT to Apply for a Private Student Loan

When you consider borrowing a private loan, keep the caveats in mind.

If you anticipate any point in the future when you might struggle to repay your debt, federal loans are much friendlier than their private counterparts.

(You can read about options you get with federal loans here.)

You should also make sure you’ve exhausted your options for scholarships and working through college before deciding to take on more debt.

Giving up four summers to work full time sounds terrible now, but you’ll be thankful when you see all your friends working to pay off $50,000 in student loans for the next 20 years.

How to Apply for a Private Student Loan

Applying for private loans is not the same as applying for federal loans. That comes with pros and cons.

One pro is you don’t have to navigate your way through something like the FAFSA again. Plus, you can probably just go to your bank and ask someone there to help you get started.

The flip side of that is every process will be a little different, so we can’t offer clear guidance.

The major con of applying for a private loan is… your credit score matters.

For a lot of students — like those just leaving high school — that’ll mean you can’t take out a loan without a co-signer (often a parent).

But this comes with a huge benefit down the line. While 43% of federal borrowers are having difficulty repaying, Christine Roberts, head of Student Lending at Citizens Bank, says a majority of private student loan borrowers are successfully keeping up on their payments.

Do You Have to Apply for a New Loan Every Year?

When you accept federal student loans, you sign a master promissory note, which basically lets your loan application and terms roll over from year to year. Heading into each school year, you don’t have to file a full FAFSA again, just update some information to confirm your financial situation.

Most private lenders, Walker explains, don’t have that option. You have to reapply for a new loan to cover your expenses each year. That could be a good thing, though.

“[It’s] an opportunity to shop around again, because there might be a new lender,” he says.

Some private lenders do offer the option, though, so be sure to ask about it.

For example, Roberts says of Citizens Bank, “While applying for aid has historically been an annual process for families, we offer a multi-year approval allowing them to fill out one full application and receive an approval through graduation.”

What Kinds of Loans Are Available?

When you look at federal student loans, you’ll see a variety of loans that come with different repayment conditions. They even have neat names to make them easy to remember (in theory).

Private loans aren’t categorized like that. You’ll qualify for an interest rate and repayment structure based on your (and your co-signer’s) credit history.

“Really the only differences (among private loans) usually are the fixed rate and variable rate,” Walker explains.

Fixed rate means your interest rate will be set when you sign and never change for the life of the loan. Variable rate means the interest rate could fluctuate with the market over the life of the loan.

The Difference Between Private Student Loans and Other Private Loans

So… you apply with a private lender and get a loan (or not) based on your credit history. Does that mean private student loans are the same as, say, your car loan? Or your mortgage?

Kind of.

Private student loans are more like those other private loans than they are like federal loans.

The main difference is the lender consults your school before giving you a student loan.

“The college is intimately involved in the private loan, because they ultimately have to certify the student’s eligibility for the amount that [the student is] looking to borrow on private loans,” Walker explains.

The lender will let the school know the amount you qualify for, and the school will let the lender know whether that makes sense for your needs there.

When Do You Have to Start Repaying the Loan?

Most students know one thing about their federal student loans: You don’t have to start repaying them until six months after you graduate — or leave — college. (Speaking of caveats, this comes with plenty.)

Private lenders often offer that option, too, but it might not be your best bet.

“With most private loans today, you have the option of paying interest during school, [paying] interest and principal [during school], or deferring,” Walker explains. “And lenders will sometimes charge more interest in a situation where the payment is deferred, because it’s taking longer for them to get cash flow.”

You also won’t find a private loan that doesn’t accrue interest while you’re in school (as with federal Direct Subsidized loans).

“Every private loan accrues interest during the in-school period,” Walker says, “and if you’re not making payments, the interest that is accruing is usually capitalized into principal at the time repayment begins.”

How Can You Find Out How Much You Owe?

If you’ve already taken out private student loans, and you’re ready to get serious about repayment, the first step is to know how much you owe… and who gets your payments.

Like application, managing private loans is slightly more complicated than federal loans — only because there’s no one-size-fits-all system.

You’ll have to stay in contact with your lender to find out where you can keep track of the status and terms of your loan. (e.g. Do you have an account on the lender’s website? Is there a special portal for borrowers?)

You can, however, use a site like Credit Sesame to get a quick overview of your student loan debt (and anything else you owe).

These sites show you a simplified credit report, so they’ll let you see how much you owe and to whom, as well as your current interest rates. If you’ve let your student loan debt slip way under the rug for a few years, this is a great way to figure out where you stand and who you should reach out to with issues.

Who Can Answer Your Questions

While the Department of Education is equipped to help you navigate your federal student loans, it’s not the best place to learn more about private loans.

If you have questions about your private loans, start by contacting the lender. This is the best place to look for information to clarify your loan agreement or learn about repayment options.

For general information, you can also ask your school’s financial aid office for guidance — even after graduation. And the Consumer Financial Protection Bureau has a whole host of information about student loan repayment.

Can You Postpone Payments on Private Loans?

Federal student loans come with built-in guidelines for deferment or forbearance of your loan payments. The guidelines for private loans are more variable, and the definitions of these terms are a little different.

Here’s what they mean, in regards to private student loans:

  • Deferment: A period of postponing or reducing payments while you’re in school, an internship or residency.
  • Forbearance: A limited period of postponing or reducing payments due to financial hardship. Rather than being tied to your status (e.g. “in school”), forbearance will be set for a limited time (e.g. 12 months).

With private loans, your options for deferment or forbearance aren’t guaranteed.

“Often they exist internally, meaning that if the borrower got into a difficult situation, they might be able to negotiate forbearance, for example, with a private loan lender,” Walker explains. “But usually the private loan lender doesn’t specify upfront what would be available.”

What qualifies you for either of these options varies among lenders, and it’ll be up to you to negotiate the options with your lender.

What Does It Mean to Default?

Defaulting on a loan means you’ve failed to make payments for several months. The entire balance of your loan becomes due immediately, and the debt could be sent to collections.

A private loan is generally defaulted after 120 days (three months) of missed payments.

When you default on federal loans, the government could start garnishing your wages or withhold your tax refund to collect payment. It’s not so easy for private lenders to get your money.

When you default on a private loan, the lender will have to go to court — and win — before enforcing measures like wage garnishment to collect on the loan.

What is Student Loan Refinancing?

Refinancing will generally mean replacing loans with a new one (or a few) that brings all your student debt under one umbrella.

This could simplify your life with one monthly payment, instead of several. It may also lower your monthly payment, improve your interest rate and/or give you more time to pay.

For some, this could be one of the best ways to pay off student loans.

You could get a lower interest rate on your loans by refinancing with a company like Credible. You can refinance anytime, so don’t hesitate to look into it, even while you’re still in school.

“The earlier you refinance, the more you can save [if you get a lower interest rate] and the faster you can pay off your loan,” Roberts says.

Enter your info at Credible to find out what your new interest rate could be.

Note: If you increase the length of your repayment period, you’ll potentially pay more in interest over the life of your loan — make sure you do the math to figure out how much money you could actually save by refinancing.

Should You Apply for a Private Student Loan?

The biggest mistake students make when applying for private loans, according to Walker, is skipping the FAFSA. He warns against assuming you can’t get federal loans.

Don’t assume your parents make too much money.

Don’t assume you won’t qualify for grants or work study.

Don’t even assume it’s too late to apply.

“You should always [fill out the FAFSA], even if it’s past the deadline,” Walker said. “It’s still worth doing so that you can make sure that you have the option of taking out federal loans.”

Leave yourself open to all options, so you can shop around and get the best deal to pay for your education.

Whatever you do, make sure you’re not desperately applying for that private loan due to lack of planning or research.

“The biggest mistake that people make across the board when it comes to financing an education,” Roberts says, “is not talking about it as a family soon enough.

“[This conversation] needs to start early and cover things like what we as a family can afford, what the student needs to contribute (if anything), debt at one type of school versus another and ability to repay following graduation.”

In a nutshell? We can’t tell you whether a private loan is right for your situation.

But we hope this information sheds light on the complicated process of paying for college — so you can make an informed decision before joining the millions of people struggling to repay student loan debt.

Dana Sitar ([email protected]) is a senior writer/newsletter editor at The Penny Hoarder. Say hi and tell her a good joke on Twitter @danasitar.