Private Student Loans: Here’s What You Need To Know

Last Updated: August 3, 2019
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For those who aren't eligible for federal loans, getting a private student loan can be a great option. However, as like any other loan, it's a debt you must pay back, so you need to make sure you've know how it works, what are the things you should pay attention to and which mistakes you need to avoid. In this article, we've summarized the main things you need to know.

Your tuition, fees, room and board, textbooks and computer are all considered types of school expenses. What that means is you can actually get a loan that will help you pay for them. It’s called a student loan.

If you’re planning to go to college or if you attended college and are looking to return for the next year you need to fill out the FAFSA form correctly. This is the Free Application for Federal Student Aid and it lets you know if you’re eligible for any money from the federal government. Through a combination of grants, work-study and loans you could be offered financial help from your school.

Those who are approved for a loan can get a lot of help too, but it’s important to remember that the money you get isn’t free.

It’s going to need to be paid back and eventually, you’re going to pay interest on it as well. That doesn’t matter for a $10,000 loan or a $70,000 loan. Eventually, you’re going to have to pay the money back and pay a lot more back on top of it. The more you take out the more you’ll pay.

How Do Private Student Loans Work?

There are two different types of loans that you can get for college and they’re going to vary depending on who is actually lending you the money. That means you’re also going to have a different process when you want to apply for these loans. If you get a federal loan it’s actually issued by the government directly. If you get a private loan it’s issued by banks and financial institutions.

Make sure you pay attention to your options before you decide to go with a private loan. If you can get scholarships, grants and even federal loans you’re going to want to look closer at those first. After all, private loans are going to require you to actually go looking for them. You won’t accidentally accept a private loan with your FAFSA package.

If you know what you’re doing when it comes to student loans you’ll be able to make your decisions better and prepare yourself more fully for what’s going to happen. So let’s take a look at private loans and what they’re going to mean.

Private Loans Have Higher Costs 

You’re likely going to see advertising for low interest when it comes to private loans, but that’s not always the case. That low interest is for the people who have the best credit scores and most people just don’t have that, especially students. If you’re getting a private loan you probably don’t really know how to build your credit score either. Research shows that only 5% or less of borrowers are actually going to get the low rates that are advertised by those private lenders.

For those who do qualify, it’s important to look at what all the fine print actually says. Are you really getting that rate for the life of the loan or is it variable and subject to change? Private student loans will often have a variable rate, which means you get a higher interest rate the longer the loan is for and you might end up spending a whole lot more than you originally thought. With federal loans you’re also going to have a fixed rate, so that private loan could be more expensive in the long run.

What Can You Really Afford?

Take a look at your tuition and how much money you can get for free through scholarships and grants. Then take a look at the loans out there.

Federal loans should be your first choice if you are going to take out any loans. They’re going to give you better terms and make for a better outcome for you. But make sure that you are careful about how much you borrow. You should never take out more than an estimated one year salary would be (your first year).

Of course, you’re going to have to look at some other things to figure out affordability. The most important is once you’ve started repayment and you have to figure out how much the monthly payment actually is.

To determine your monthly payment there are three things to consider. How much you borrow, your interest rate and how long you have to pay it off.

If you have longer to pay it off you’re likely going to have smaller payments but you’ll end up in debt a lot longer. If you have a low interest rate you’ll be putting more of the money you pay directly on the principal, which means it goes a whole lot further.

The key is to make sure you understand your payment and you know how you’re going to pay that bill. How are you going to make it fit in with all the other bills that you have? Is it going to work out easily in there?

Private Loans Can’t Be Cancelled

Just like with a federal student loan you aren’t going to have the opportunity to cancel or forgive your private loans. But then again, there are exceptions to every rule and they apply to federal loans. Those who work in a non-profit space for 10 years may get forgiveness or if you fit certain other guidelines. Private loans don’t have those options. That means your only way out of those loans would be to go through bankruptcy, which is an even more difficult process.

You’ll Need a Co-Signer

A credit check is going to be an absolute necessity when it comes to private loans and if you don’t have a good history or a long enough history it’s going to mean trouble for you getting that loan. You may need someone who is willing to co-sign for you. That means they’re willing to pay for the loan that you get if for whatever reason you can’t or don’t.

Keep in mind that you’ll need to be careful about your credit score when you apply for loans. Each of those companies is going to pull your credit report and the report of your co-signer to decide if you’re qualified and what they’re willing to offer.

Shopping Around is a Key

Federal loans aren’t going to give you a whole lot of options. They’re pretty much one size fits all and you can either take the terms that are offered or you can leave them. You don’t get to choose anything, not even the bank you want to work with.

You should never take the first offer that’s given to you when it comes to private student loans. These loans can be shopped at all different lenders and you should make sure you’re look at several. That’s the way you’re going to know the options for terms and rates and how you can choose the best option.

Remember, rates aren’t going to be everything though. You need to look at all the terms that apply now and in the future. Plus, look at interest rate reductions, bonuses for automatic payments, forbearance, deferment and flexible payment options. You want to know that these things are available and what they’re going to give you for options. They might not be there, but you won’t know unless you ask.

Make sure once you decide where you’re going to get the money from you only take out the amount of money you absolutely need. Don’t take more than that. And make sure you know what you’re signing and what you’re getting before you do it.

Bump Up Your Payments

Paying even just a little bit more than what you actually owe each month is going to make a huge difference when it comes to paying off your loans. Of course, you’re going to have to go through a process for that as well. The loan company doesn’t want to make it easy for you. If you just make a larger payment than necessary your provider will apply it forward, meaning it applies to next months bill. You have to let them know specifically if you want that amount put toward the principal of your loan. That’s what’s going to save you money.

Keep in mind that even a little bit of extra money each month can make a big difference. If you pay even $30 extra each month you’re going to make a large dent in the amount of money you pay and how much you actually spend in paying off those debts.

Maximize Your Tax Deductions

When it comes to paying off your federal loans especially (though sometimes your private ones) you may be able to deduct your interest when you pay taxes. For those who earn under $80,000 who file single or under $140,000 who file married jointly, there’s a deduction of up to $2,500 per year. Those savings could then be put towards paying off your loan! Of course, keep in mind that if you earn between $65,000 and $80,000 (for single people) you won’t get the full $2,500, but only a portion.

For those who are still in school or are in training for a specific job or just graduated there is a separate option for $2,500 in education expenses. You can’t get both, but if you don’t qualify for one you can definitely go for the other.

Make sure you’re getting what you can to get the most money back and to save yourself as much as possible. You don’t want to spend more money than you have to.

Refinance or Consolidate – What’s The Difference?

If you’re trying to get out of debt as quickly as possible you may see these two words thrown about. When you consolidate you’re combining every loan that you have (or at least the ones that you want) into a single loan with a single payment and a set interest rate. That rate is generally going to be an average of what you’re paying on each loan separately. It means that your payments are going to be easier for you to make, but you still owe the same debt overall.

When it comes to refinancing you’re usually taking out a new loan that pays off the old ones and puts everything together. Usually this is because you’re going to get a lower interest rate. You make a single payment every month and that also helps you get yourself out of debt more quickly. Keep in mind that which one is best for you is going to be up to you.

Also, if you follow either of these you’re likely not going to be able to deduct your interest payments as a tax deduction.

Bottom Line

Private loans are generally not going to be the best option. They’re usually going to have some very different terms and they’re not going to have the benefits that you would get with a standard federal loan. That means you should always read through the options and the fine print before you make a decision.

Make sure you know exactly what it’s going to cost and how long you’re going to be paying. But of course, make sure that you do this for your private and federal student loan offers.