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Private student loans can be a viable option if you’ve exhausted your allotment of federal loans and other free funding sources. They come with higher loan limits, and the borrowing costs are sometimes lower compared to their federal counterparts.
That said, they aren’t without limitations worth considering. You won’t get the luxury of accessing income-driven repayment plans, loan forgiveness options (if you’re eligible) and the other benefits that come with federal loans. And you could spend more than you anticipated in interest if you have a lower credit score.
Evaluate the pros and cons of private student loans before applying to determine if they’re ideal for your financial situation.
Private student loans vs. federal student loans
Private student loans are a way to finance your education through a private lender; repayment terms and interest rates vary by lender. By comparison, federal student loans are issued by the Department of Education and come with standard benefits and fixed rates.
In most cases, college students should turn to federal student loans first if they need help financing their education after free money options have been exhausted. This is primarily because federal loans give you access to income-driven repayment plans and loan forgiveness programs, but also because there’s no credit check for most loans, and everyone who qualifies gets the same interest rate. With that said, most federal loans limit how much you can borrow each year and in total, and borrowers with excellent credit could find lower interest rates with private loans.
Pros of private student loans
In the right situation, private student loans can have some clear benefits. Here are some to keep in mind.
Can be cheaper than federal loans
If you’re an undergraduate student, you likely won’t find anything cheaper than a federal student loan, especially if you haven’t had the chance to build a credit history. But graduate and parent loans through the Department of Education are pricier than undergraduate loans, both with interest rates and the upfront loan fee.
If you have a solid income and a high credit score, you could potentially score a lower interest rate than the federal government charges. Also, private student lenders typically don’t charge an upfront fee.
Depending on the situation, it’s good to compare what you might qualify for with private lenders and what the federal government offers.
Higher borrowing limits
If you’re attending an expensive school, you may not get the amount you need if you only go through the federal government for student loans.
If you’re an undergraduate student, for instance, you can borrow between $5,500 and $12,500 per year, depending on your year in school and dependency status. The lifetime maximum is $31,000 for dependent students and $57,500 for independent students.
With private loans, however, you can typically borrow up to the total cost of attendance, minus any financial aid received, every year, giving you more flexibility to get the financing you need.
Open to those who don’t qualify for federal student loans
Borrowers not eligible for federal student loans may find they qualify to borrow private student loans. The requirements for private borrowing are different and will likely take your finances into account, but this may be an especially helpful option if you do not qualify for other types of financial aid.
Potentially tax deductible
Up to $2,500 in private student loan interest each year may be deductible on your tax return. Lenders will issue a form 1098-E indicating how much interest you’ve paid over the previous year. Consult the IRS website or a tax professional for details.
Cons of private student loans
Although private loans can be beneficial in certain situations, some major drawbacks make them less appealing for most students.
No access to income-driven repayment or forgiveness
Federal loans offer income-driven repayment plans that reduce payments based on borrowers’ income, a great option for borrowers struggling to meet high monthly payments. Most private lenders don’t extend that same generosity; the only way to lower monthly payments is to go through the refinancing process.
Also, if you work as a teacher or in some other form of public service, you may qualify to have some or all of your federal loans forgiven after you meet certain criteria. Private lenders don’t have that option, nor would they be included in any executive action canceling student debt.
Interest rates are based on creditworthiness
In some cases, you can qualify for lower interest rates with private lenders than what the federal government offers. But private lenders offer a range of rates, and unless your income and credit score are stellar, you may end up with a much higher rate than you want.
Of course, many private lenders allow you to apply with a co-signer, such as a parent, which can improve your chances of getting favorable terms. But even that’s no guarantee.
It’s also important to note that the lowest private student loan interest rates are generally variable, fluctuating over time with market conditions. If you get a variable-rate loan, your monthly payment could increase.
There’s no federal subsidy
Undergraduate students with financial needs may qualify for subsidized federal student loans. With these loans, the federal government pays your interest while you’re in school, as well as during future deferment periods.
With private loans, though, there is no subsidy, so you’re on the hook for all the interest that accrues on your debt.
Usually cannot be discharged in bankruptcy
Private student loans generally cannot be discharged when a borrower files for bankruptcy. Due to an overhaul of the bankruptcy code in 1978, borrowers must now prove that their student loan payments cause “undue hardship” and prevent them from a minimum standard of living before the courts consider discharging this type of loan.
Deferment and forbearance are more limited
Though these options are standard for most federal student loans, deferment and forbearance options are not guaranteed with private student loans. The availability of these payment pauses may depend on your lender’s unique terms.
How to apply for a private student loan
If you need a private student loan to cover your college costs, here’s how to apply for one.
- Compare lenders. Private student loans require strong credit history from borrowers. Review each lender’s eligibility requirements to see what you’ll qualify for. Compare them based on interest rates, fees, repayment plans and relief options, if any.
- Get prequalified. Once you have a handful of lenders in mind, complete prequalification forms to see which ones you’d get approved for. Prequalification is a soft credit check — not a hard one — so completing these won’t ding your credit score and cause it to drop. Receiving quotes from several lenders gives you a better idea of which is best for you.
- Complete an application. Once you have the right lender in mind, complete a full application. Prepare important documents, like personal and employment information, income verification, school details and tax forms. If you’re applying with a co-signer, they’ll need these documents as well.
- Wait for approval. Your lender might request additional information from you or your school, so approval might not be instantaneous. Stay on alert, and if your lender needs additional forms or documents, send them in as soon as possible. Once approved, find out when repayment starts. For some lenders, that might be while you’re still in school. Others might offer deferment while students are still enrolled at least half time.
The bottom line
Ultimately, private student loans are worth considering if you have unmet financial need that can’t be covered by federal loans or other forms of free aid. They come with a host of benefits that could make them a good fit for your financial situation. Despite their drawbacks, shopping around with different lenders can help you find options with competitive terms and affordable monthly payments.