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Pros and Cons of Private Student Loans
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When considering student loans for college, it’s wise to max out federal loans first since they offer relatively low interest rates and flexible repayment plans. But if you need additional funds, private student loans can help. Just make sure to review the pros and cons of student loans from private lenders before taking on more debt.
Private student loans pros and cons
Private student loans, also known as alternative student loans, can help with financial gaps not covered by federal financial aid. Let’s take a closer look at the main benefits and downsides of a private student loan for college, university or other post-secondary school.
Pros of private student loans
Rewards for excellent credit
Your credit score doesn’t matter with most types of federal student loans. Congress sets the Federal Student Loan interest rates, with everyone receiving the same rate regardless of credit.
With private student loans, though, you can be rewarded if you have (or your cosigner has) excellent credit. Currently, you may find private loan annual percentage rates as low as 3.99%. Although federal student loan rates for undergraduates are set at 4.99%, graduate students can expect to pay 6.54% for unsubsidized Direct loans or 7.54% for grad PLUS Loans.
Higher borrowing limits
Alternative student loans typically come with higher borrowing limits than federal debt. If you’re attending a pricey school, your financial aid package might not cover all education-related expenses.
With federal student loans, the aggregate limit as of Dec. 7, 2022, was $31,000 for a dependent undergraduate or $57,500 for an independent undergraduate. For graduate student loans, the cap is $138,500 — including what you already received as an undergrad.
Depending on your degree level, you can borrow up to 100% of your cost of attendance with alternative student loans. If you experience a “funding gap” because federal student loan caps restrict you, private student loans can help bridge the difference.
Statute of limitations
When you default on your federal student loans, there is no statute of limitations. No matter what happens or how long your debt remains in default, you must repay your loans eventually. The government can even garnish your wages and tax refunds to repay your federal student loan debt.
One of the major pros of student loans from a private lender is a statute of limitations when you default. The timeline varies by state but can range from three to 10 years. After this, lenders have limited options to collect from you.
Although defaulting on student loans is detrimental to your credit and rarely advised, it’s reassuring to know that a private student loan default has an expiration date should the worst happen.
Quick application process
Many private lenders may offer a speedier application process than the Free Application for Federal Student Aid (FAFSA). In fact, private lender Earnest allows you to upload all documents from your phone, with most borrowers receiving a lending decision within 72 hours. By comparison, FAFSA can take up to five days for electronic submissions and 10 days for paper submissions.
Options for international students
The U.S. Department of Education doesn’t offer federal financial aid to most international students. However, some private lenders will lend to non-U.S. citizens. You will still need to meet the specific criteria, such as attending an eligible college on at least a half-time basis, having a valid student visa and most likely adding a U.S. citizen as a cosigner.
In addition, you can consider personal loans for non-U.S. citizens to help fund your education abroad.
Alternative funding if you lose financial aid
You might qualify for private student loans even if you lose your eligibility for federal aid. For example, you might receive little to no financial assistance if your expected family contribution (EFC) is too high.
In fact, private lenders are very unlikely to limit your funds due to having too high of an income, which can be an issue with federal loans. On the contrary, having a high family income can work in your favor here since it can help unlock more favorable interest rates and terms.
Cons of private student loans
Ineligible for income-driven repayment or federal forgiveness
With federal student loans, you can turn to income-driven repayment plans if you struggle to meet monthly payments. These plans cap your loan payments at a small percentage of your income. However, private student loans are ineligible for income-driven plans.
While some private lenders offer financial hardship options like deferment or forbearance, it’s not the same as having your regular payment capped at a percentage of your income. Additionally, private student loans aren’t eligible for federal forgiveness programs such as Public Service Loan Forgiveness (PSLF) or student loan forgiveness for teachers.
That said, you can try to find a loan repayment assistance program from your state or employer to help pay off private student debt.
Interest rates might be variable
Your federal student loan has fixed interest rates for the duration of the loan. They will never change, regardless of what happens in the national economy.
Some alternative student loans also offer fixed rates, but this isn’t always the case. Instead, you might find yourself with a variable rate.
If interest rates rise over time, so does your variable interest rate — and your monthly payment. Hybrid rates advertised by private lenders blend fixed and variable rates and carry a similar risk.
Typically, you can choose between a fixed or variable rate when you borrow a private student loan.
No federal subsidy
Subsidized federal student loans come with an interest subsidy, meaning the government pays your interest while you’re in school or even in repayment. Interest won’t accrue, saving you hundreds or thousands on your debt.
However, this option doesn’t exist with private student loans. Interest accrues from day one; in some cases, you might need to make interest payments while still in school. If you don’t pay the interest as you go, it’s added to your debt as capitalized interest when you finish school.
A cosigner may be necessary
Though most federal student loans don’t require a cosigner, you might need one for your private student loans — even if you have a good credit history. After all, you might not be working and earning an income while enrolled.
A cosigner is legally responsible if you can’t repay your debt. Missing a payment — or worse, defaulting on your loans — will damage your cosigner’s credit, and collectors can go after them for payment. Check to see if your private student loan offers cosigner release, which lets your cosigner off the hook once you can assume full responsibility for the debt.
Higher risk of overborrowing
Private loans allow you to borrow up to 100% of your cost of attendance, minus other aid you’ve already received. However, borrowing the maximum incurs more interest over the duration of your loans, thus increasing your loan payments.
Just because a higher limit is available doesn’t mean you should accept it all. If you find yourself overborrowing, you can take steps to return unused loan funds.
Private debt isn’t always discharged after death
Federal loans are discharged if the borrower passes away. The debt will be cleared and won’t count against your estate.
With private student loans, however, lenders could try to collect against your estate in the event of death. While private student lenders can’t collect from relatives for non-cosigned debt, they can still reduce the value of the inheritance you leave behind.
Plus, some private loans automatically default if your cosigner passes away, even if you’ve been keeping up with payments.
Start with federal student loans when possible
Even though alternative student loans come with some advantages, the reality is that many students are better off starting with federal student loans.
Start funding your education by using your savings and applying for scholarships. Next, turn to federal student loans. Federal debt comes with protections and flexible repayment options that could be a financial lifesaver in the long run.
Turn to private student loans when you can’t close your funding gap by other means. Even with scholarships and federal loans, you may still need a private student loan to pay for school.
If that’s the case, ensure you understand the pros and cons of student loans from a private lender before you borrow. Once you do, shop around and compare your options to find a loan with the best rate and terms for you. Most importantly, only borrow what you need to avoid drowning in debt down the road.