If you need to take out student loans to help pay for college, you’ll have two main choices. You can either take out a federal or private student loan.
While federal student loans get a lot of attention, you may not be as familiar with private student loans and how they work. In this guide, we’ll provide a private student loans definition and explain their pros and cons.
What is a private student loan?
A private student loan is simply any loan that isn’t made by the government.
Private student loans are made by various lenders, such as community banks, credit unions and online lenders. State agencies and schools may offer private student loans as well.
How are private student loans different from federal loans?
Now that you know the basic private student loans definition, you’ll need to know the several ways they differ from federal loans.
Repayment plans and student loan forgiveness
Private student loans aren’t able to match many of the federally funded benefits, repayment plans or forgiveness options.
Private student loans have higher annual loan limits than federal student loans. With federal student loans, you can borrow no more than $57,500 as an undergrad and $138,500 for graduate students (including what your borrowed as an undergrad).
But with many private student loan lenders, you can borrow up to 100% of your cost of school attendance. This can make private student loans an overflow option for students who have exhausted their federal loan options and still need more funding.
If you qualify for a subsidized federal student loan, the government will pay your interest while you’re in school.
There are no subsidized private student loans. You’ll need to pay all the interest yourself.
The terms and conditions of federal student loans are set by law. But private student loan lenders are free to set many of their own rules.
That means private student loans could differ from federal student loans in these additional ways:
- When payments begin: Most federal student loans don’t require payment until after you’ve graduated from school and have exceeded your six-month grace period. Many private student loans require payments to begin immediately upon loan disbursal.
- Credit check: Most federal student loans don’t require a credit check, but most private student loan lenders do.
- Prepayment penalty: Federal loans don’t have a prepayment penalty fee, while some private loans may.
It’s important to note that private lenders vary widely in the rules and benefits that they offer. Many private student loans don’t come with prepayment penalty fees. And if you choose one of the best private student loan lenders, you may have an interest-only payment option or total deferment while you’re in school.
How can you get a private student loan?
To get a private student loan, you’ll need to apply with a private student loan lender.
As mentioned earlier, many private student loan lenders will check your credit. It’s also common for them to require proof of income. If you don’t have great credit or any income, you may need to find a cosigner to qualify.
If you’re going to take out a private student loan, you’ll want to shop around to make sure that you’re getting the best deal. To get started, compare the pros and cons of private student loans.
You may also want to use comparison tools like Credible to help you find the best offer for you.
Do private student loans have lower interest rates?
The possibility of getting a lower interest rate with a private student loan depends on what type of loan you’re taking out.
Direct undergraduate loans
For the 2019-2020 academic year, the interest rate for undergraduate Direct Subsidized Loans and Direct Unsubsidized Loans is set at 4.53%.
It’s going to be hard for any private loan to beat that rate, even if you (or your cosigner) have amazing credit. If you did get an offer for a private loan with a lower interest rate, there’s a good chance that it’s for a variable-rate loan.
Direct graduate and PLUS loans
However, private student loans have a better chance of beating out federal student loans on graduate and PLUS loans.
As of August 2019, Direct Unsubsidized federal graduate loans come with 6.08% interest, and PLUS Loans are set at 7.08%. If you have a healthy income and good credit standing, one of the best private student loan lenders may offer you a rate under 6%.
Depending on the lender you choose, you may be given a few repayment options to pick from. CommonBond, for instance, gives private student loan borrowers four choices:
- Deferment: You don’t make any payments until after you graduate.
- Fixed $25 payments: You pay $25 each month until after you graduate.
- Interest-only payments: You pay the interest on your student loans while you’re in school but don’t pay toward the principal until after you graduate.
- Full payments: You begin making full principal and interest payments immediately.
Keep in mind that with the first two options, you’ll accrue interest while in school and that interest capitalizes once regular payments begin. Interest-only payments can be a good choice if you want to avoid interest capitalization.
Common repayment periods for private student loans include five, seven, 10, 15, and 20 years. That gives a good deal of flexibility to choose whatever repayment period you feel most comfortable with.
But keep in mind that, unlike federal student loans, you won’t be able to change your repayment plan later with private student loans.
Pros and cons of private student loans
Here are a few of the pros and cons of private student loans that you’ll want to keep in mind:
- Higher loan limits: If you’re going to an expensive private school, you may tap out of your federal student loan aggregate limit fairly quickly. But private student loans can help bridge the funding gap.
- Strong credit lowers your interest rate: Having good credit doesn’t get you a better deal with federal student loans. But with private loans, you’ll be rewarded if you’ve handled credit responsibly.
- Private loans adhere to your state’s statute of limitations: Conversely, there’s no statute of limitations with federal student loans. If you default on federal student loans, the government can garnish your wages and tax refunds. Federal loans won’t ever just “go away.”
- You lose out on federal student loan benefits: Benefits like income-driven repayment (IDR), interest subsidies and loan forgiveness programs like PSLF and Teacher Loan Forgiveness are no longer available through private student loans.
- You lose out on hardship options: These options include deferment, forbearance, and death and disability student loan forgiveness. The latter two are a big deal because it can be very difficult to repay student loans when you’re permanently disabled, and no one wants their student loans to follow them to the grave.
Thankfully, many of the best private student loan lenders now offer death and disability forgiveness as well as some forbearance and deferment options. This is another reason why it’s important to shop around before choosing a private student loan lender.
As a general rule, you’ll want to max out federal student loans before turning to private. And if you do need to take out private student loans, make sure to do your homework. Compare interest rates, repayment options and other benefits that private lenders have to offer so that you find the best deal.