What Is a Private Student Loan & How Does it Work?
Private student loans are useful tools that you can use to pay for education expenses that your federal loans don’t cover. While federal loans are the better choice, private student loans may be necessary to fill in the gaps.
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College is expensive. According to the National Center for Educational Statistics, the average 4-year institution charged an annual $26,593 in tuition and fees during the 2016-17 school year, and costs have only risen since then.
Most students don’t have a spare $100,000 to cover their college tuition, so many use student loans to help them pay for school. The Department of Education does offer some financial aid to students in the form of grants and loans, but these aren’t always enough.
Private lenders have begun offering student loans to bridge the gap. This guide will tell you what private student loans are, how they work, who can get one, and how to tell if they’re right for you.
In this guide:
- What is a private student loan?
- How do private student loans work?
- Where to find private student loans
What is a private student loan?
A private student loan is a loan offered by a lender other than the government. This can be a bank, credit union, or specialized online lender.
Undergrads and graduate students can use private student loans to pay for all sorts of education costs besides tuition, including housing fees and living expenses. Each lender has its own requirements for who can borrow and its own limits on loan amounts.
Private student loans do not have many of the advantages that federal loans have, so it’s in your best interest to fill out the FAFSA and use federal loans before turning to private ones.
Pros & cons of private student loans
Pros
- Fewer limits than federal loans
- The lending process can be more flexible
- You might get a lower interest rate
- Statute of limitations on collection
Cons
- You typically need a good credit score or a cosigner with a strong credit history
- Loan forgiveness is not an option
- You’ll likely receive higher interest rates
How do private student loans differ from federal loans?
There are major differences between federal and private student loans.
- Your credit counts. With private student loans, your credit score, or your cosigner’s, usually plays a significant role in the amount you can borrow and the interest rate you pay.
- Rates are higher. The federal government subsidizes its loans to help keep costs low. With private loans, you’re bearing the full burden, so rates tend to be higher unless you have excellent credit.
- Fewer borrower protections. If you use a private student loan, you won’t be eligible for protections like student loan forgiveness or income-driven repayment plans, and you may not be eligible for deferment or forbearance, either.
Federal loans tend to be the better option for students, so you should max out your federal loan limits before opting for a private student loan.
How do private student loans work?
The thing about private student loans is that there is no one-size-fits-all answer to this question. Each lender’s loan will be unique and have its own features.
>> Read more: How Do Student Loans Work?
Eligibility
Every lender will have its own eligibility requirements, but there are a few that will hold true from lender to lender.
The most obvious is that you have to be a student to get a student loan. How each lender defines this can vary. Some lenders only offer loans to students in traditional undergraduate college programs.
Others might be willing to offer loans to those in certification programs, graduate students or Ph.D. students.
You’ll also need a good credit score or have a cosigner that has good credit. If you don’t, however, there are student loan options for those with bad credit and those without a cosigner.
You also can’t typically borrow more than your school’s certified cost of attendance.
Application
Just like any other loan, you’ll need to fill out an application if you want to get a private student loan. That means providing basic information, including your and your cosigner’s (if applicable):
- Name
- Address
- Social Security Number
- Income and employment status
- Assets
- Expenses like rent or mortgage costs
- Tax returns
Your lender will also want to see proof of our status as a student. Some will accept just the name of your university and what you plan to study. Others will want documentation from your school. Most schools can offer documentation showing that you’re a student if you require it.
Rates
When you take out a private student loan, you’ll have to pay interest on the amount you borrow. There are two types of interest rates you should be familiar with: fixed rates and variable rate rates.
Fixed rates or variable
Fixed-rate loans have an interest rate that will not change over the life of the loan. You’ll pay the same amount each month until the loan is paid back and can calculate exactly how much the loan will cost on the day you get the money.
With a variable-rate loan, the interest rate can change as the market changes. When market rates go up, the variable interest rate will increase, and so will your monthly payment. On the other hand, if rates go down, your loan’s rate and the monthly payment will also drop.
Typically, variable-rate loans begin with slightly lower rates than fixed-rate loans to compensate for this increased risk, but fixed-rate loans make more sense for most borrowers who plan to take 10 or more years to repay their debt.
You can learn more in our guide to variable vs. fixed-rate student loans.
Interest is unsubsidized
Another thing to keep in mind is that private student loans are unsubsidized. This means they begin to accrue interest from the day you get the money.
Interest rates and fees vary by lender and borrower, but typical rates for private student loans fall between 4% and 13% APR.
Disbursement
If you’re approved for a private student loan, the lender won’t just hand you a check or put money into your bank account. Usually, the lender will disburse your loan directly to your school.
If you have already paid some of your tuition or have federal loans, you can work with your school to have any amount in excess of your tuition refunded to your checking account. You can use that leftover cash for living and other expenses.
Repayment options
When you apply for a loan, you have to choose how long you’ll have to pay back the loan. This is called the loan term. Typically, you can choose from repayment terms of 5 to 15 years.
Most lenders won’t make your begin payment until six months after you graduate or fall below half-time student status. This is called the grace period.
However, a few lenders do require low flat-rate or interest-only payments while you’re still in classes. While these loan payments are typically small, they still increase your financial burden while you’re studying.
It’s not all bad, though: making interst-only payments while you’re in school can also prevent your loan’s accrued interest from ballooning to an unsustainable amount after graduation.
Where to find private student loans
You have many financial institutions to choose from when considering private student loans. You can borrow money from banks, credit unions, or dedicated student loan providers, each with its own benefits and drawbacks.
And as with any financial decision, you should shop around to make sure you get the best deal. If you need a private student loan and want help comparing rates our guide to the best private student loans is a great place to get started.
