How Does a Private Student Loan Work?

If you need help financing your college education, student loans can help. It’s best to start with federal student loans, but they may not cover all your expenses. Private student loans can help you bridge the gap in that case.

Before you apply, it’s important to note the differences between private and federal student loans. 

So how does a private student loan work, and how can you get one? Here’s what you need to know.

In this guide:

• What is a private student loan?
• How do private student loans work?
• How does interest work on a private student loan?
• How to apply for a private student loan
• What if you’re denied a private student loan?

What is a private student loan?

One definition of a private loan is: an educational loan originated and serviced by a private lender. Popular private student loan companies include the following:

• Earnest
• SoFi
• Sallie Mae
• Discover
• College Ave

It’s essential to consider the pros and cons of private student loans. Like federal student loans, private loans can help you pay for eligible educational expenses. 

But unlike federal loans, private student loans don’t come with the same benefits, including access to forgiveness programs, income-driven repayment plans, and generous forbearance and deferment options.

Private student loans are also credit-based, which means you need to meet specific credit and income requirements to get approved or have a cosigner who meets them. Instead of a flat, fixed interest rate for all who qualify, your interest rate can be fixed or variable and is based on your creditworthiness.

How do private student loans work?

Understanding how student loans work can help you determine whether they’re the right fit for you.

How much can you borrow?

Each lender has a range of loan amounts, which can start around $1,000 or $2,000. Many go up to the total cost of attendance for the academic term as determined by your school. Lenders may also require you to subtract other financial aid received from your eligibility.

You can request to borrow a certain amount, but the amount you get is based on what the lender determines after reviewing your total costs and other aid. Lenders may also consider your and your cosigner’s credit history, income, and other factors to calculate your loan amount.

Lenders may also have a maximum aggregate loan amount, ranging from $75,000 to $120,000 for undergraduate students and $150,000 to $400,000 for graduate students.

When are the funds disbursed?

You can apply for loans for a single term, an entire academic year, or even multiple years. The funds are often disbursed around the start of each semester—your school will determine the exact timing. 

How are the funds disbursed?

Most lenders disburse student loan funds to your school. If funds are left over after paying tuition and fees, room and board, and other eligible expenses, your school will give you the remaining balance, which you can use for other approved costs. 

You may receive the funds through a paper check, direct deposit, or even a debit card, depending on what you’ve set up with your school.

What can I use the funds from private student loans for?

Approved expenses for private student loans are often the same as for federal student loans. That includes the following:

• Tuition and fees
• Room and board
• Books and supplies
• Off-campus housing
• Transportation
• Computers and software
• Other necessary equipment

Of course, lenders aren’t looking over your shoulder or watching your bank account to ensure you only use your loan proceeds for approved purposes. Using loan funds for lifestyle-related expenses can leave you with more debt, affecting your financial health for years after you graduate.

How does repayment work?

Private student loan repayment terms can range from five to 20 years, but your options may vary by lender. 

Potential options include:

• Deferred repayment: As with federal student loans, you won’t have to make payments while in school or during your grace period after you graduate, leave school, or fall below half-time enrollment. Depending on the lender and type of loan, the grace period can be six months, nine months, or longer.
• Immediate repayment: If you can afford it, you may make full payments right away.
• Interest-only repayment: With this option, you’ll pay only the monthly interest that accrues on your loans. Then, once you’ve left school and reached the end of your grace period, you’ll start making full payments for the length of your repayment term.
• Fixed repayment: Your lender may allow you to make a low fixed monthly payment, often $25, while in school and during your grace period. After that, you’ll start making full monthly payments.

You’ll choose which repayment term and process you want when you apply for your loan. Read the entire loan agreement before signing it to ensure it’s the right one. 

How does interest work on a private student loan?

Private lenders may offer fixed interest rates or both fixed and variable interest rates. With a fixed-rate loan, your interest rate will remain the same for the life of the loan, giving you more predictability. In contrast, variable interest rates can fluctuate over time based on economic conditions.

Variable rates often start lower than fixed rates, but not always. And your rate can go down, but the opposite is also true. You can choose which type of interest rate you want, but your lender will determine your interest rate based on your and your cosigner’s creditworthiness. You can view lenders’ annual percentage rate (APR) ranges on their websites. 

You can choose when you start making monthly payments, but interest starts accruing on your loans upon disbursement. If you don’t make payments while in school, the lender will capitalize the accrued interest once repayment begins and add it to your balance. 

For example, let’s say you take out a $10,000 loan with a 7% interest rate and a 10-year repayment term and graduate two and a half years later. Assuming a six-month grace period, here’s what your balance will look like with each possible repayment option after three years:

Repayment option	Monthly payment	Balance after 3 years
Deferred repayment	$0	$12,100
Fixed repayment	$25	$11,200
Interest-only repayment	$58.33	$10,000
Immediate repayment	$116.11	$7,693.03

Note: If you choose a deferred or fixed repayment option, your monthly payment at the start of your full repayment term will be higher due to the increased balance. 

How to apply for a private student loan

For federal student loans, you just fill out the Free Application for Federal Student Aid (FAFSA) to apply. Do this before considering private student loans to maximize your student loan benefits. 

With private loans, you must apply with the lender you choose. You don’t need to do so as early as possible. Remember that the whole process can take several weeks, so don’t wait until right before your term starts.

Before applying, check your credit score using a free service, such as Experian’s credit monitoring service, to gauge your credit health and whether you need a cosigner (which is common). 

Minimum credit score requirements often start in the mid-600s, but the higher your score, the better your odds of qualifying for a low interest rate.

Why you should shop around 

Once you’re ready, it’s important to compare interest rates, repayment terms, and other features from at least three lenders. Many private student loan companies will let you prequalify and get rate quotes with a “soft” credit check, which won’t hurt your score. 

These quotes aren’t final—you’ll get final terms after you submit an official application and undergo a “hard” credit check—but they can help you narrow down your list of options to a single lender.

Once you decide on a lender, you’ll apply online through its website, providing details about yourself, your cosigner (if applicable), your school, and more. 

If you’re approved, the lender will submit the details to your school for certification and then return to you with a loan amount. If you agree to the terms, you’ll sign the loan agreement, and the lender will disburse your loan based on your school’s schedule.

What if you’re denied a private student loan?

If you’re denied a student loan, the lender will provide you with an adverse action letter detailing the reasons. If you applied on your own, you might have better luck if a parent or loved one with good credit is willing to cosign the application.

Otherwise, you might need to look into other funding sources, such as scholarships, grants, work-study, or a part-time job. 

You could also check with your school’s financial aid office about a short-term institutional loan or consider a less expensive school.