college

4 tips to navigate private student loans

College girl in room
Highlights
  • Take a very hard look at any private student loan before signing up.
  • Loan origination fees can add to the cost of a private student loan.
  • Take advantage of the free college money out there before getting a loan.

If you're thinking of borrowing from a bank to help pay for college, join the crowd. The rapidly growing volume of private student loans is on track to exceed the number of federal loans by around 2025, says Mark Kantrowitz, publisher of FinAid Page LLC, an informational website operator on student financing.

But while taking out a private student loan may be popular, it's not a move to be taken lightly.

"Students and parents are kind of living in a new economic reality today, so they have to take a very hard look at any private student loan before signing on the dotted line," says Justin Draeger, president of the National Association of Student Financial Aid Administrators in Washington, D.C.

Here are four tips to guide you when navigating the private student loan market.

Use up federal loans first

Before you start shopping in the market for a private student loan, make sure you have exhausted every opportunity for federal financial aid. Federal loans have fixed interest rates and allow you to defer payment while you are in school and during times of economic hardship.

"The federal loan program has several different repayment options," Draeger says. "One of them limits the repayment amount to a portion of a borrower's income, so borrowers can be assured that their student loan payments would never exceed a certain amount. Those types of provisions are very rare in private education loans."

Even private lenders looking for your business agree that a federal student loan is a better buy.

"Absolutely take advantage of the free money that's out there in terms of scholarships, grants and financial aid. When they do need a loan, the best loan for a student to get is a federal Stafford loan," says Mike Weber, spokesman for Credit Union Student Choice, a credit union service organization based in Washington, D.C.

Know the interest rate formula

The interest rate on your loan will be tied to either the prime rate or the London interbank offered rate, or Libor. Kantrowitz says the best deals are no-fee loans whose rates are based on Libor plus 2 percent or prime minus 0.5 percent, similar to what the Federal PLUS Loan program offers.

Kantrowitz says the cost of a Libor-based loan will usually be lower over the long term, because Federal Reserve statistics show that the spread between the two indexes -- Libor and the prime rate -- has been increasing. It's also important to note that some college loans have variable rates that increase during the repayment period.

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Rates also can vary, depending on whether the student applies for the loan independently or with a co-signer.

"The credit quality in either case is going to help determine the rates," says Mary Kay Bean, a spokeswoman for JPMorgan Chase. "It's most likely that for a student who doesn't have a credit history, to have a co-borrower is going to help them to qualify for a better rate on their loan than if they were to do it on their own."

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