When it comes time to pay for your college education, you probably already know that you should start by submitting your FAFSA application to see if you qualify for any financial aid, including federal student loans.
But what can you do if your federal aid doesn’t cover all of your college expenses?
While private student loans are typically more expensive and carry fewer benefits and protections compared to their federal counterparts, for millions of Americans they form an important piece of the college puzzle.
Below, we take a look at private student loans and answer all of the questions you’ve got: What is a private student loan? How do they differ from federal student loans? How do you apply for them? And more.
What is a private student loan?
A private student loan is a loan offered to college students by a private lender, such as a bank, credit union, or other lender. Because they are not federally controlled, private student loan lenders can be much more selective over who they lend to, what their eligibility requirements are, and what they charge in the form of interest rates and fees.
Types of Private Student Loans
While federal student loans come in a number of varieties, each with its own benefits, interest rates, and rules, private student loans are not typically categorized in any particular way. That being said, private lenders will often offer some combination of the following types of student loans:
- Undergraduate student loans
- Graduate student loans
- Professional student loans
- Parent student loans
Because private student loans are not regulated as rigidly as federal student loans, it may also be possible to borrow loans for other costs associated with college, which it is not typically possible to use federal loans for. This may include living expenses, etc.
Federal Student Loans vs. Private Student Loans
Student loans can be issued to a borrower either by the federal government or by a private lender. There are a number of important differences between federal and private student loans that you should be aware of, as these differences can severely impact your ability to borrow and repay your loans.
Some of the most important differences to keep in mind are:
- The Lender: With federal student loans, your lender is the U.S. Department of Education, and your loan will be managed by your federal loan servicer; with private student loans, your lender is a private corporation.
- The Interest Rate: With federal student loans, your interest rate is set by Congress; with private student loans, lenders can charge whatever interest rate they wish.
- Borrowing Limits: Federal and private student loans have different maximum borrowing limits.
- Availability of Subsidies: Some federal student loans carry subsidies that will save you hundreds or even thousands of dollars in interest over the life of the loan. Private loans do not typically offer subsidies.
- Eligibility: Eligibility for federal student loans is set by Congress. Private lenders are able to choose whatever requirements they wish.
- Repayment Options: While private lenders may offer a handful of repayment options, federal student loans typically come with many more options, including income-based repayment.
- Forgiveness: Under certain circumstances, certain types of federal student loans may be forgiven outright.
- Ability to Postpone Payments: Federal student loans come with a sixth month grace period after you leave school, during which time you are not required to make payments. You can also choose to place your loans in deferment or forbearance during periods of economic hardship. Private student loans typically do not offer such generous benefits.
- Consolidation Options: You can consolidate all of your federal student loans into a single new federal loan if you wish to do so. To consolidate private student loans, you will need to refinance your debt with a private lender.
- Prepayment Penalties: Some private lenders may charge you a penalty for repaying your student loans early. Federal student loans will never charge such penalties.
Pros and Cons of Private Student Loans
- Typically higher borrowing limits compared to federal student loans
- Increased flexibility over what you can use them for
- Potential to be rewarded for having an excellent credit score
- Typically much higher interest rates compared to federal student loans
- Interest rates may be variable
- Typically much higher fees compared to federal student loans
- Lack of government subsidies
- No guarantee that you will be accepted
- Fewer repayment options
- Typically no forgiveness options
- Deferment and forbearance not offered as readily
- Borrowers with poor credit/no credit history may be penalized with higher interest rates
- May need a cosigner to qualify
How to Apply for a Private Student Loan
In order to apply for a federal student loan, all a borrower needs to do is submit a FAFSA application. Unfortunately, applying for a private loan is typically much more complicated.
The first step is to find a borrower who will offer you the best deal. You can do this on your own, by comparison shopping, or you can look for a loan through an online student loan marketplace, which will do the comparison shopping for you.
Once you have found the best deal you will then need to follow the particular application process that that lender required from potential borrowers. Typically, this includes filling out a number of forms designed to help the lender gauge your creditworthiness; i.e., how likely you are to be willing to repay your loans.
While the exact information you’ll need to apply for a private loan will vary from lender to lender, it typically includes your:
- Social Security Number (SSN)
- Contact information (Address, phone, email)
- Date of birth
- Proof of employment, such as recent pay stub
- Monthly rent/mortgage bill
- Most recent tax returns
- Personal reference
If you are applying with a cosigner, which you may need to do to qualify for lower interest rates, you will need to supply this information for them as well.
You will then submit a formal application form, which will give the lender permission to perform a hard credit check. If you are approved for a loan you will be notified and give the opportunity to review it before accepting or rejecting the terms offered to you.
Private Student Loan Eligibility
While eligibility for federal student loans is set by Congress, private lenders are able to select their own requirements which potential borrowers will need to meet to qualify for a loan. These requirements will vary from lender to lender.
That being said, most lenders will require that:
- You are enrolled in an eligible school or program
- You meet certain age and citizenship requirements
- You meet their credit threshold (or apply with a cosigner who does)
- You meet their income threshold (or apply with a cosigner who does)
Specific lenders may have other unique eligibility requirements, as well.
Private Student Loan Interest Rates
The banks and institutions that lend private student loans are businesses; they lend student loans in order to make a profit. Therefore, they have a lot of leeway in terms of what they can charge in interest rates. While federal student loans are set by Congress, private loans are not.
Note: It is worth noting that private student loans often carry much, much higher interest rates than federal student loans. It’s for this reason that we typically recommend borrowers only turn to private loans if they have already exhausted their federal alternatives.
Typically, the interest rates charged by a private lender will depend on a number of factors, including:
- Your credit score: Borrowers with a higher credit score will typically qualify for lower interest rates.
- Your income: If you have a history of high income, you may qualify for a lower interest rate.
- Whether the loan is variable or fixed: Loans with fixed interest rates will often carry rates which are higher than variable interest rates. That being said, variable interest rates may rise in the future.
- Whether or not you apply with a cosigner: If you apply with a cosigner, you remove some risk for the lender, because they know that they can turn to another person to pay your bill if you can’t. Often, this will translate into lower interest rates.
- The general market: Most private lenders base their rates on the general credit market. When credit is tight, borrowing will be more expensive.
Private Student Loan Fees
Whether or not a private lender charges a loan origination fee will depend on their internal policies. If they do charge such a fee, it will typically be represented as a percentage of the total loan, which can equal hundreds of dollars on average.
Additionally, while rare, some private lenders may charge a prepayment fee in the event that you repay your student loan ahead of schedule. Other fees may also exist, and should be outlined in your loan terms.
Private Student Loan Lenders
Dozens of banks, credit unions, and other lenders offer student loans. Some of the more popular and well-known of these private lenders include:
- Sallie Mae
- Citizens Bank
- College Ave
- Wells Fargo
Private Student Loan Repayment Plans
By law, federal student loans must offer borrowers a number of repayment plans. Private loans are not required to offer such variety. That being said, in order to compete with federal lenders, many private student loan lenders offer at least some flexibility in repayment.
For example, with private student loans, a borrower can often choose between:
- Immediate Repayment: You must begin making regular monthly payments immediately after the funds have been disbursed, even while you are in school. Because this lowers your principal more quickly than other options, this will save you the most interest over the life of the loan.
- Interest-Only Repayment: While enrolled in school, you must only make monthly payments which cover any interest that has accrued on the loan. While this will not lower your principal, it will prevent it from rising while you are enrolled in school. Then, after you leave school, you will be required to make full payments.
- Partial-Interest Repayment: This is similar to Interest-Only Repayment, except instead of fully paying down your accrued interest you will only pay a portion or it each month. If you cannot pay the rest of the accrued interest, it will capitalize and be added to the principal of your loan, at which point it will begin to accrue its own interest.
- Full Deferment: While enrolled in school, you will not be required to make any payments whatsoever. This will allow you to focus on your schoolwork, but because it means you are accruing much more interest compared to other options, it also means that this is typically the most expensive of options.
As mentioned above, private lenders are not required to offer you this flexibility. If the availability of one of these repayment plans is important to you, then you should be sure to look for a lender which offers it.
Should you borrow a private student loan?
Ultimately, only you can decide whether or not a private student loan makes sense to you. While private student loans can help you fill the gaps not covered by federal student loans and other forms of financial aid, they tend to carry higher interest rates and fewer borrower protections compared to their federal counterparts, and it’s important for you to keep these considerations in mind before choosing to borrow.
Alternatives to Private Student Loans
Because private student loans are so much more expensive compared to federal student loans, it’s typically recommended that you use federal student loans and other financial aid before turning to private loans. Submitting your FAFSA application (you can do so here) is an excellent place to start.
Before turning to private student loans, it can also be wise to look for ways to lower your college expenses. You may be surprised at how much you are able to cut from your bill—savings that can minimize your private loans, or even avoid them altogether.