After colleges send out their financial aid award letters, any gaps that are left will need to be filled with college savings or private student loans. Unfortunately, navigating private loans isn’t as easy as it sounds. A 2012 survey by Young Invincibles, a youth advocacy nonprofit in Washington, D.C., shows that among students who only took out private loans (no federal loans), nearly 70 percent were not informed of their other options. Before signing on the dotted line, here’s what you need to know about private student loans.
Federal loans come with mandatory borrower protections, including deferment and forbearance options, the ability to postpone repayment six to nine months after graduation (depending on the type of loan), and extended and income-based repayment options. But protections, interest rates and fees vary from lender to lender for private loans.
“(Students) don’t really understand that the effective rates (on private loans) are considerably higher and they’re quite expensive,” says Steven Roy Goodman, educational consultant and admissions strategist with Top Colleges, an educational consulting firm in Washington, D.C.
Goodman says that before opting for private loans, students should max out their federal options and ask their financial aid office for help.
“There’s nothing wrong with politely asking an undergraduate college or a graduate school to revisit your financial aid package so that it might be more affordable to you,” he says. “A thousand dollars means a lot more to an individual than it does to a major research university.”
Federal student and parent loans come with fixed interest rates, making it easy to predict monthly payments. Kay Lewis, director of financial aid and scholarships for the University of Washington in Seattle, says many private student loans have variable interest rates.
“… If you have an initial lower interest rate, that looks really attractive compared to some of the federal loans,” she says.
While variable private student loans may start at a low interest rate, they could easily double or triple over the 10 years or more it will take you to pay it back. While some banks have rolled out fixed-rate private loans in the past few years, others allow students to convert their variable-rate loans to a fixed-interest deal.
Students will need to pass a credit check to get the best rates on private loans, unlike Stafford loans and additional funds through the federal Perkins loan program. And since undergrads don’t usually have a lengthy credit history, that oftentimes means enlisting a co-signer — specifically, one who’s ready to take on the debt burden should the student bail on repayment.
Even students who are diligent in repayment can have their credit scores impacted before taking out a loan. When shopping for private loans, lenders pull the student’s and the co-signer’s credit reports to determine what interest rate they are qualified to receive. According to the online lender LendingTree.com, families have two weeks to safely comparison-shop for loans. After that, every pull can temporarily lower the credit score by up to five points.
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“… A student who may be on the cusp or whose co-signer may be on the cusp of being eligible (for a loan) could knock themselves out,” says Kendra M. Feigert, director of financial aid for Lebanon Valley College in Annville, Pennsylvania.
The private-loan world is a whole different ballgame when it comes to how much a bank will lend. While some lenders restrict private-loan borrowing to the total cost of attendance minus financial aid, others simply have a yearly loan cap, leaving it up to the students to decide how much debt is too much.
Federal loans, on the other hand, come with strict limits. Dependent undergrads with Stafford loans can only borrow up to $31,000 over their college tenure, independent undergrads can borrow up to $57,500, and graduate and professional students get take out up to $138,500. Borrowers who take out parent Direct PLUS Loans can take the total cost of attendance minus any financial aid their family received.
Whether seeking private or federal loans, Beth Cragar, associate dean of admission for financial aid at Sewanee: The University of the South, in Tennessee, advises students to look at their own finances before overborrowing.
“… We will still occasionally get the question, ‘How much can I borrow?’ It makes me cringe,” she says. “We encourage students to closely examine their budget and only borrow when necessary. And then, only (borrow) what you need — not the maximum you can get.”
The silver lining to taking on student debt — be it private loan or federal — is that families could get a sweet tax deduction. According to the IRS, families with student loans may deduct the interest they pay each year, up to $2,500.
There are a few catches, though. To get the deduction, families must have a student who is enrolled at least half time in an accredited institution and adjusted gross incomes of $80,000 or less ($160,000 for joint filers).
Only loans that were taken out from third-party lenders and were solely used to pay for education count. That means that under-the-table “loans” from Grandma, funds from an employer-sponsored tuition reimbursement or remission plan, and money withdrawn from a home equity loan or line of credit are off the table.
While private loan borrowers don’t enjoy the same capped interest rates and borrower protections as federal loan borrowers, private lenders are just as protected from loan default as the federal government. Like federal loans, private student loans can’t be dismissed in bankruptcy except in death or total-and-permanent disability. That means that even if the variable interest rate on your loan spirals out of control, you still have to pay it back — or else you could face collections, wage garnishments and potential lawsuits.
“When I have an individual that’s sitting on the other side of the table that I know can pull the plug and have the debt dismissed in bankruptcy … I’m motivated to work a deal out,” says Mitchell Weiss, adjunct professor of finance at the University of Hartford in West Hartford, Connecticut, and author of ” Life Happens: A Practical Guide to Personal Finance from College to Career.”
“… Private lenders don’t have that hammer sitting over them … They’re willing to stretch out the (loan) term, but they’re not reducing interest, they’re not abating loan principal, they’re not doing what the government is doing.”