What Are Private Student Loans?

Private student loans are offered through banks, credit unions, or private lenders. You can use private student loans to supplement federal student loans or as an alternative way to pay for college. Private student loans are designed to fill the gap between federal loan limits and current college costs. 

Private loans use credit score and credit history, annual income, and other factors to determine the loan amount. Unlike federal loans, there is no limit on private student loans so you could secure more funding. Find out the pros and cons of private loans to understand if they’re right for you.

How do private student loans work?

Private student loans work much like other loans from banks or traditional lenders. Lenders use credit scores, annual income, savings, and other factors to determine the loan amount. The loan amount may be higher than federal loans, but the interest rate may also be higher. If you don’t have a good credit score or proof of income, you may need a co-signer to secure a private student loan. 

Private loans may have variable interest rates instead of fixed interest rates. A fixed interest rate means the interest rate is set throughout the loan term. With a variable interest rate, your interest rate will change according to market rates. 

Private loans may also have longer terms than federal student loans. While some have a limit of 10 years, other private loans can be up to 20 years. 

Advantages of private student loans

The primary benefit of private student loans is that they can provide additional funds to cover the cost of tuition and related expenses, which you may not have the funds to cover with other forms of financial aid. Private student loans are also a great option for those who have maxed out their federal loan eligibility, as they provide an additional source of funding. 

Keep in mind that private loans usually offer a maximum of the cost of attendance at your college minus financial aid. Some private lenders also have a lifetime limit on private loans. 

Disadvantages of private student loans

While private loans may seem like a great idea, they can offer significant drawbacks. 

Higher interest rates

Private student loans usually have higher interest rates than federal student loans. For that reason, students should max out their options with federal student loans before applying for private loans. 

Early repayment

Many private loans require payments when you’re still in school. Some only require interest payments or smaller payments while you’re still in school, it’s an additional stress. In contrast, federal student loans don’t require repayment until you’ve graduated. 

Credit check

Private loans require a credit check. You must have good credit to qualify. You may also need proof of income. If you don’t have a good credit score or don’t have a credit history, it can be difficult to secure a private loan without a co-signer.

If you are working on building up your credit or improving your credit score, MoneyLion is here to help! Credit Builder Plus (CB+) is our powerful credit-building membership, and it’s designed to help our members build or repair their credit, save, establish financial literacy and track their financial health.

CB+ can help you build or improve your credit with access to a Credit Builder Plus loan. A Credit Builder Plus loan is a small loan that is held in a secure account while you make monthly payments. As you make payments, CB+ reports them to the major credit bureaus, which can help boost your credit score with on time payments. Plus, you get access to some of the loan funds as soon as they are approved, so you can use them for whatever you need.

CB+ is a smart way to help improve your credit while paying off your debt. By improving your credit score, you can qualify for lower interest rates on future loans or refinancing options. And by paying off your Credit Builder Plus loan on time, you can reduce your debt-to-income ratio, which could also improve your credit score.

You may need a co-signer

Co-signers on private student loans face several restrictions. For students, getting a co-signer can help them get a better interest rate on private loans and build a credit history. For the co-signer, there are some substantial disadvantages. 

If the student fails to pay back the loan on time, it will impact the co-signers credit score. The new debt will also impact their debt-to-income ratio. And of course, they are ultimately responsible for repaying the loan if the student fails to do so. 

Lack of debt consolidation options

A debt consolidation loan can be a smart way to consolidate your monthly debt obligations. But this is not usually available for private student loans. That means you’re left making payments according to the original loan terms even if you’re able to consolidate other debt. 

Lack of debt forgiveness programs

With federal loans, you’ll have options for income-driven repayment and forgiveness programs. This can make your final debt obligation significantly less or allow for lower payments for those with lower incomes. Private loans don’t come with the same benefits. Regardless of your income, you’ll need to make the agreed-upon payments and won’t be eligible for loan forgiveness programs.

Limited postponement options

Each lender has its own policy and may or may not offer opportunities for postponement or lowering your payment. But most private lenders have stricter repayment policies and fewer postponement options than federal student loans. When you take on a private student loan, you or the co-signer will be obligated to pay the agreed amount in full each month. 

Private student loans vs. federal student loans

Are you still wondering about private student loans versus federal student loans? There are several major differences.  Federal student loans come with significant benefits like fixed interest rates and income-driven repayment plans.

Private loans made by banks, credit unions, or other organizations have variable terms and conditions set by the lender. Overall, private student loans are generally more expensive and offer less flexibility than federal student loans.

Other key differences:

• You don’t need a credit check for federal student loans.
• Interest rates are generally lower on federal student loans.
• For federal loans, you don’t need to pay until you are out of school.. 
• Some private loans may have prepayment penalties.
• Private loans offer fewer postponement options.
• Private loans aren’t eligible for loan-forgiveness programs.

How to choose the right private student loan 

It’s always a good idea to explore all other options before settling on private student loans. In addition to federal student loans, you may be eligible for scholarships or grants from private organizations, through your university or program.  

If you decide to pursue private loans, make sure to read the terms and conditions before agreeing to a student loan. It’s important to understand the specifics of the loan, including interest rate, co-signer responsibilities, payment start dates, pre-payment options, and postponement options. 

Alternatives to private student loans

Alternatives to private student loans are diverse. In addition to federal loans, many students choose to attend community college for the first two years of college. After two years of general education, you can transfer to a state university to save significantly on tuition. You can also look at cheaper schools or vocational programs to save on college costs. 

Some students also consider working while in college. Students regularly work in jobs like babysitting or childcare, as servers or hosts in restaurants, as resident assistants, delivery drivers or Uber drivers, or doing online work.

Optimizing your options

You shouldn’t immediately rule out private student loans, but you should approach them with caution. You’ll want to graduate with the best financial options available. For this, consider all available options, including federal student loans, scholarships, grants, less expensive colleges, community college, and working while in school. 

Regardless of your current financial situation, take the time now to research options and read the fine print. This can help ensure you’re getting the best possible financial opportunities now and for your future.

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