Private college loans are often a funding source of last resort, a financing mechanism used only after all grants and federal aid programs have been tapped. Regardless of their standing with borrowers, private college loans remain some of the most common sources of financing for those who attend colleges that are too expensive to be paid in full by federal student loans. We’ll explain the ins and outs of private college loans, and how you can make use of private loans to finance a college degree.
Private vs. Public
To understand private loans, one must first understand public loans to know how they differ. Private college loans are very different from public loans in a number of ways. The biggest difference, however, comes not from the type or interest rate (we’ll get to these later) but the approval process.
Applying for, and receiving, a federal college loan is as easy as being capable of signing on the dotted line. Public lending programs like Stafford loans make no distinction between good and bad borrowers, and the rate you pay is set by Congress, fixed for the life of the loan. If two people were to apply for a Stafford loan at the same time, one with a 500 credit score and another with an 800 credit score, each would get the same loan.
This isn’t the case with private college loans, however. Private college lenders can be, and are, very particular about who they lend money to. Whereas a student can receive several thousands of dollars in federal loans each year without an income, or credit, a student could not do the same through private lenders. Private lenders need to see that a student or cosigner has good credit history, and enough income to pay for the small monthly payments that start at the time the loan is issued.
Almost all private college loans start with an amortization schedule which requires repayment, or monthly payments against the loan balance, as soon as the loan is made to the student. Public loans defer payments until the student has graduated, and thus no payments are due while the student is still in school.
The amount you would pay toward a private college loan while in school is nothing compared to the amount you’d pay after graduation. Sallie Mae, for example, offers a private college loan with $25 payments while the student is in college. Obviously, $25 per month will pay only a small amount of the interest due, but it does say a lot about the responsibility of the student while in college. Once the student graduates, the payments balloon to match the amount borrowed, and the student finally starts reducing their principal balance.
Interest rates also create another rift in the student loan market. Direct Loans, the division of the Department of Education which manages student loans, issues all Stafford loans to students at an annual percentage rate of 6.2% per year. The interest rate is non-negotiable, regardless of your ability to repay. One major gain to students, however, is that the interest rate on all federal Stafford loans is that interest is fixed at 6.2%. The interest rate will not rise or fall with changes in interest rates, and the payment a student makes to pay back his or her loans will be the same one-year after graduation as it is 10 years after graduation.
Private loans are different in this regard. A private loan is far more likely to be made with a variable interest rate, which is set by a premium to the lender’s borrowing costs. If interest rates rise, so too do the interest rates a student pays on their student loan debt. The same is true if rates fall; the student benefits by having a lower interest rate.
Naturally, changes in the interest rate can affect the monthly payment for private college loans. In the event of rising interest rates, the rate at which a private college loan compounds will speed up. The monthly payments will also increase. Many people accept private college loans at a variable rate while in college, hoping to later consolidate their debts into fixed rate student loans after graduation.
Which Loan is Best?
Which loan is best for your needs depends greatly on how you plan to finance your education. Ideally, students should seek to borrow all that they can from federal loans, which may have a higher, but fixed, rate of interest. Plus, since federal loans do not require a credit check or income verification, acceptance is guaranteed.
However, once all possible funding opportunities are exhausted, private college loans make for a great funding source for your education. Realize that a private college loan will require a consigner if you do not make $20,000 or more per year, and that the loan you receive can have drastically different terms than a federal Stafford loan. As with any major purchase, it pays to shop around.