A Guide to Private Loans
Federal loans are made by the federal government under the Direct Loan Program for students and under the PLUS loan program for parents. For most students, the Federal Direct Loan is the best borrowing option. After the student has exhausted their eligibility for the Direct Loan, borrowing options broaden to loans to:
- parents using either the PLUS program or private lender programs
- students with a parent or other creditworthy co-signer
NCAG’s Parent Loan Navigator tool quickly and easily analyzes and compares Federal PLUS loans and private loans with one click, offers a Loan Manageability Index, and provides a marketplace of private loan options.
Private loans are offered by banks, credit unions, state-based nonprofit agencies, and online lenders. They can be a useful tool for parents who have good credit scores who wish to help their student. The help can come in one of two ways: as a co-signer with the student on the student’s private loan or directly as the borrower on a parent loan. Many parents choose the former so that the debt is not solely in their name.
For parents with good to excellent credit scores, private loans may be a less expensive option to the Federal PLUS loan.
Students Should Exhaust Federal Options First
When borrowing to pay the college bill, students should use the Federal Direct Loan Program as the first source of loans. The Federal Direct Student Loan program is the best deal for students. Among other benefits, it:
- limits how much students can borrow each year.
- offers fixed interest rates to make budgeting easier.
- provides flexible repayment options if the student goes back to school or has trouble paying.
Only after a student has exhausted their eligibility for the maximum available federal loans should private loans enter the conversation.
How Private Lenders Evaluate Borrowers
Unlike undergraduate federal loans, private loans require a credit review. Lenders look at credit score, income, existing debt, and employment history to determine whether to approve the loan and at what interest rate. Borrowers with strong credit are offered lower rates; those with limited or imperfect credit histories are offered higher rates or may be declined entirely.
Most college students have little or no credit history, which means most will not qualify for a private loan on their own. This is where co-signers come in.
The Co-Signer Role: Benefits and Responsibilities
A co-signer, most often a parent, agrees to be equally responsible for repaying the loan if the student cannot or does not pay. Adding a creditworthy co-signer allows the student to access better interest rates than they could qualify for alone. It also means the co-signer’s credit is on the line. If the student misses payments, the co-signer’s credit score is affected. If the loan goes into default, the lender can pursue the co-signer for repayment.
Most private lenders offer a co-signer release option, which allows the co-signer to be removed from the loan after a certain number of on-time payments, typically 12 to 48 months, and the student has demonstrated creditworthiness on their own. Families should ask about this option when comparing lenders.
Fixed vs. Variable Interest Rates
Private lenders typically offer both fixed and variable rate loans. A fixed rate stays the same for the life of the loan, making budgeting predictable. A variable rate is tied to a market index and can rise or fall over time. Variable rates often start lower, but they carry the risk of increasing significantly over a 10- or 15-year repayment period. For most borrowers, the predictability of a fixed rate is worth more than the potential short-term savings of a variable rate.
Almost always, the lowest interest rate on a lender’s menu is a variable rate loan made to a borrower with a very high credit score. This rate is often called a “Teaser rate” because it is enticingly low, but offered to few customers. Families should research what the maximum interest rate can be on a variable rate loan and how much it can be increased in any period. The nightmare scenario for variable rate borrowers is taking an apparently lower cost variable rate loan and seeing the interest rate and monthly payments soar later.
What to Compare When Shopping Lenders
Not all private loans are equal, and it pays for families to compare options carefully. Key factors to evaluate include the interest rate and whether it is fixed or variable, the loan origination fee if any, the repayment term and options, whether there is an in-school deferment option, the co-signer release policy, and any borrower protections such as deferment for financial hardship. State-based nonprofit lenders are often state agencies or an agency associated with the state that enables them to offer lower interest rates than commercial lenders. Families should find the state-based lending agency in their state or the state in which the college is located to see if they offer a lower-cost loan.
What Private Loans Cannot Do
Private loans generally do not offer repayment plans that are as flexible as federal loans. They do not qualify for any federal loan forgiveness programs, such as the Public Service Loan Forgiveness Programs. Deferment and forbearance options, if they exist at all, are often more limited as determined by each lender individually. If a borrower experiences financial hardship after graduation, federal loans will likely offer more flexibility to adjust.
The Bottom Line
Private student loans can fill the gap for families when federal options have been exhausted and the numbers make sense. But they require more research and a clearer-eyed look at the total cost and terms and conditions than federal loans require. Families should compare lenders to each other and the Federal PLUS loan, understand the co-signer commitment, choose fixed rates when in doubt, and borrow the minimum amount needed to close the gap.