Understanding Private Student Loans
Understanding Private Student Loans:
Generally speaking there are two categories of student loans:
- Loans provided by the federal government (Perkin Loans, subsidized or unsubsidized Direct Loans, or Direct PLUS Loans) and
- Loans provided by private lenders (banks, corporations, colleges, or state-based organizations).
This article will help you with understanding private student loans. It will discuss the second type of student loans, known as private student loans or alternative student loans. Because federal student loans usually offer better interest rates and more flexible repayment terms, financial aid advisors urge students to research federal loan options first. Use the following links to learn more about: Federal Student Loans and how to apply for them by completing the FAFSA.
Unfortunately, federal student loans don’t always cover the full cost of a college education – even for students who demonstrate financial need. The following guidelines may help you better understand your borrowing options, when it comes to private loans.
Considering Student Loans
How do you know whether you need a private student loan?
You should pursue student loans as the last step in the financial aid process – after you have received a financial aid package from your chosen college, outlining the types and amounts of aid various sponsors may be willing to extend to you, if you are eligible. If the cost of your program still exceeds the amount you can afford to pay, you may want to consider private loans.
“We typically counsel students to take private loans when there are no or very limited options,” explains Bob Andersen, Director of Financial Aid at Western Illinois University. Ruth Vedvik, author of The Financial Aid Handbook, is even more cautious. “Only take them in dire emergencies,” she advises. “Like if you have a small shortfall in funds the last semester before graduation.”
Why are private loans seen as less desirable than federal government loans?
For one thing, private loans are usually tied to variable interest rates, whereas federal loans offer fixed interest rates. With private loans, your interest rates may rise and increase the total amount you’ll need to repay. Over many years of repayment, a private loan might end up costing you a lot more than a federal loan taken out for the same amount.
Secondly, federal loans may be available to qualifying students, regardless of their credit scores. Private loans, by contrast, are only awarded to students with fairly decent credit. And you may not receive the lenders’ best interest rates unless your credit is excellent. If you have poor credit or an un-established credit history, you may qualify for a private student loan by securing a cosigner. “Private loans are completely market driven, and the best rates only go to students and cosigners with excellent credit,” confirms Andersen.
Thirdly, federal loans offer more flexible repayment plans and, in some cases, loan forgiveness options. It may be easier to defer a federal loan (if you lose your job or suffer a disability), and penalties for late payments may be less severe. For example, federal loans aren’t considered to be in default until nine months of payments are skipped. Depending on the terms of your contract, some private lenders may declare that you’ve defaulted after just one or two missed payments.
Finally, many federal loans can be consolidated. If you take out loans for two or more academic years, you might receive separate bills for each sum. Consolidation helps students combine different loans into a single bucket, which sometimes reduces the total amount that is due each month. Private loans cannot be consolidated with federal loans.
How do you know if your state houses a student loan program?
Many in-state agencies offer supplemental, fixed-interest student loans. These loans are designed to bridge the gap between college costs and students’ financial aid packages. Usually, they are only available to legal residents of the state and/or students attending college within the state. Even though they are state-affiliated, these loans aren’t necessarily funded through state budgets. To find out if your state houses a student loan program, you should visit your state’s department of higher education.
Do schools and colleges offer student loans?
It never hurts to ask. According to Bob Andersen, some colleges do offer their own loan programs. At Western Illinois University, for example, two student loan programs sponsor a handful of students each year. “These are typically similar to endowed scholarships,” Andersen explains, “because the loan capital was donated by a donor who set up criteria and a repayment [system] to keep the program solvent.”
Comparing Student Loans
As you’re shopping for private student loans, you’ll learn a lot about the different selling points some lenders advertise in order to attract borrowers. Don’t gloss over the details, and don’t settle for the first offer you find. Compare several lenders, by asking the following questions:
What is the interest rate, and how will it vary?
Most private student loans come with an interest rate that is tied to a fluctuating market index. The rate could go up or down over the course of your repayment plan. If your loan comes with a variable interest rate, you’ll want to ask if there’s any cap on how high it can go. You’ll also want to know how often the rate is adjusted.
Some lenders will offer very low rates or fixed interest rates to borrowers/cosigners with excellent credit. Be sure to ask if these are just introductory offers that will eventually expire. Lenders might also offer interest-lowering incentives if you agree to enroll in an automatic bill pay program.
Can loan payments be deferred while you’re in school?
Many private lenders will allow borrowers to defer payments until after graduation or until they are no longer enrolled in school on a full-time basis. But you’ll want to confirm this, because some loan payments are immediately due upon receipt of funds.
While the option to completely avoid loan payments throughout your entire degree program may seem attractive, it’s advisable to make interest payments on your loan as soon as you can. “It’s the best way to keep the loan manageable,” says Andersen. Some students fail to recognize that interest on deferred loans can be capitalized, or added to the principle balance. If you wait to make any payments until your deferment is over, you’ll actually be paying back a higher principle, which will accrue even more interest.
Some students defer loans while completing one degree, and then continue to defer payments while completing an advanced degree. Years of deferment can dramatically increase the amount you owe. You may also be charged a deferment fee.
What will the monthly payments be, and how many are required?
Even with a variable interest rate, your lender should be able to provide a chart or some other illustrative estimate, to explain what your payments will look like each month. You might also ask about fees that are sometimes bundled into the principle loan balance – for example, origination fees, disbursement fees, insurance fees, or late fees.
According to Bob Andersen, private loans are typically repaid in terms of 10 to 25 years, depending on the loan volume. Be sure to ask lenders if there’s any penalty attached to paying everything back early. If you have the means, shortening the length of your repayment period could save you a significant amount.
After leaving school, what are the options for deferment and forbearance?
Even if you’ve already deferred payments during your time as a student, you may be eligible to defer them again, under certain circumstances. Every loan agreement is different, so you should ask which of the following events (if any) could entitle you to postpone payments:
- Full-time enrollment in an academic program
- Military deployment
- Loss of job
- Full-time volunteer service (e.g. Peace Corps role)
- Internship or student cooperative experience
There is usually a time limit for each type of deferment, so you can’t continually enroll in college programs – for example – to avoid paying your debt.
Forbearance is similar to deferment, but is mainly used in cases of financial hardship. If your lender grants you forbearance, you can temporarily stop making payments on your loan. In most cases, interest will continue to accrue, and will be added to your balance (capitalized) when you resume payments.
Applying for Student Loans
When should you apply?
Ruth Vedvik recommends applying several months before your enrollment term, though one month may be sufficient. New lending requirements state that borrowers must be allowed a “rescission” period between the date when the loan application is approved and the date when the funds are dispersed to the school. This means there may be a 10 to 15-day lag between your approval and your ability to pay your school.
What kind of paperwork or documentation is required?
Most private loan applications are available online or over the phone. For preliminary approval, you can often enter estimates of your income, your savings and assets, and your educational plans. Many private lenders will only offer loans to students who are completing degree programs and/or studying full-time. Private loans may not be available for individual courses or certificate programs. In completing the loan application, you’ll submit to a credit check, which allows the lender to view your credit report.
If you’re approved, you’ll be asked to sign a promissory note and possibly submit paperwork to substantiate the estimates you provided. Advisors at your school’s financial aid office can help you coordinate necessary materials and signatures.
Is a new loan application required for each semester or academic year of study?
“Normally a new application is required for each academic year,” reports Bob Andersen. But some colleges and private lenders do provide short-term, single semester loans, some of which are designed to be repaid, in full, by the end of the semester.
Qualifying for Student Loans
What is a cosigner, and who needs one?
Many traditional college students (18 to 22 year-olds) have never held full-time jobs or had the opportunity to establish a credit history. Lenders can’t rely on past data to weigh the likelihood these students will repay hefty loans. And without documented income, their ability to repay is uncertain.
Cosigners (often parents or other relatives) are employed, credit-worthy individuals, who agree to assume the debt burden if the borrower is ever unable or unwilling to pay. Bob Andersen counsels traditional students, “for private loans this is typically the best idea, since the interest rates are quite high if you don't have a qualified cosigner.”
What can you do if your student loan application is denied?
You could always reapply through a different bank/company, but lenders typically look at the same factors and use similar formulas in making their approval decisions. Either you or your cosigner should possess the following:
- A good credit history
- A manageable debt-to-income ratio (monthly bills on auto, home, and student loans shouldn’t equal more than 37 percent of your monthly pay)
- A stable residence (e.g. several years in the same location)
- A stable job
Spending Student Loans
Do loan funds get paid to the school or the student?
“Typically the proceeds are in the student's name, but are delivered electronically or by check to the school,” says Andersen. “The school applies the check to the student's account, and will then make a refund for [any excess] amount after the bill is paid.”
Some schools issue student loan refunds on debit cards. Instead of getting a check, students receive bank cards that can be used at ATMs or anyplace credit cards are accepted. Unfortunately, many of these cards come with hidden fees or even balance inquiry charges. If your college offers loan refund debit cards, ask about alternative, direct deposit options.
Can loans include costs besides tuition, like living expenses?
In addition to tuition costs, private loans may be used to pay for college fees, room & board, books, supplies, computers, transportation, and personal expenses, explains Andersen. “We also add costs for study abroad programs.”
When borrowing beyond the cost of tuition, you may be asked to outline your financial needs – including school-related costs and basic living expenses, like car insurance or phone bills. Your college’s financial aid office can work with you to establish a realistic refund amount. The school and/or the lender may set limits in terms of how much you can borrow above basic tuition. Either way, it’s smart to think it terms of basic necessities. If you use even a little of your refund for fun and entertainment, you could be paying interest on $10 movie tickets for the next 10 years.
What happens to the loan if a student decides to drop out or transfer?
“Standard loan payments are started as soon as the bank is notified of the [student’s] withdrawal,” cautions Andersen. Your lender may offer a grace period (see below) of several months, but you should make efforts to communicate your plans – whether they involve changing colleges or dropping out altogether – as soon as possible.
Depending on your reasons for leaving, and how far into the semester you are, your school may offer refunds of varying percentages – for example, 50 percent of the semester’s tuition if you leave before the end of the second week of classes. If you’re thinking of leaving school, doing so early in the semester may improve your chances of qualifying for a refund, and thereby helping you to back more or your loan right away.
Repaying Student Loans
When are student loan payments due?
According to Bob Andersen, student loan payments may be due immediately upon receipt or deferred until you leave/graduate from college. Since many students elect to defer payment, it’s important to save and organize of all your loan paperwork (account numbers, terms and conditions, lender contact information, etc). You should also keep your “grace period” in the back of your mind. After leaving school, you may have several months of leeway before a first loan payment is due; this is known as grace period. If you haven’t already done so, use this time to incorporate payments into your monthly budget.
It is your responsibility to make loan payments on time, whether or not you receive a bill in the mail. For that reason, it’s advisable to contact your lender whenever you change your address, your name, or withdraw from school. Not sure how much you borrowed or who from? Students with federal loans can look up their loan data by accessing the National Student Loan Data System (NSLDS). If you’ve lost track of your private loan information, you may wish to contact your college’s financial aid office.
Are there any incentives for making consistent, on-time payments?
Payments on your student loan will likely be reported to all the major credit agencies. A history of on-time payments may help you establish a good credit score and/or a positive credit report. Some private lenders will negotiate lower interest rates with students who consistently make on-time payments. Some lenders will release cosigners from a student loan agreement, after one or more years of responsible remittance.
What is defaulting, and what are the consequences?
In short, defaulting means failing to make payments on a loan. The exact definition of defaulting may vary, depending on the terms of your loan, which are outlined in the promissory note you are required to sign. After missing just one or two payments, your loan account may be considered “delinquent.” If you continue to skip payments, the loan will progress to default status. Some private loans go into default after a single missed payment.
The process for recovering from default also depends on your lender. If you default on a federal student loan, there are several ways to resolve the matter and potentially clean up your credit by rehabilitating or consolidating loans. If you ignore the loan altogether, the government may eventually garnish your weekly paychecks, your tax refunds, and revoke your eligibility for certain government programs.
If you default on a private loan, consequences may be even more severe – including hefty penalties, higher interest rates, and major black marks on your credit report. If you qualified for your loan with a cosigner, he or she could also face serious collection actions and adverse credit ratings. Bad credit can prevent you from buying a home, from securing a car loan, or even from receiving certain job offers.
Most importantly, Ruth Vedvik stresses, “you cannot ever, ever get out of repaying your loan – not even in bankruptcy.” Some organizations are working to change bankruptcy laws so that needy students aren’t chained to loans forever. Either way, it’s crucial to research and understand what you’re borrowing and how you will manage repayment.
Who can students contact for support?
Regardless of who services your student loan, there are usually people who can help you. If you have problems or concerns related to your loans, you should contact your private lender or loan servicer first. If you don’t reach a satisfactory resolution, you may wish to contact your college. Even if you’ve already graduated or left school, your former financial aid office may supply quick answers or point you toward student support resources.
If you have thoroughly attempted to resolve federal loan repayment issues with your school, your loan servicers, and any involved collection agencies, but you still can’t reach a satisfactory resolution, you may wish to contact the Federal Student Aid (FSA) Ombudsman. For private loans, you may wish to contact the Better Business Bureau or StudentLoanBorrowerAssistance.org.
Some of the preceding information was obtained from the U.S. Department of Education’s (USDE) online resource: www.fafsa.ed.gov