Paying for college can seem like an insurmountable feat for students and their families amid the rising cost of a university education — especially for those who can’t afford to pay out-of-pocket after maxing out federal student loans, grants and scholarships. When federal aid comes up short, private student loans can be one way to bridge the college financing gap.
While private loans can be a legitimate funding option after federal aid has dried up, borrowers should know the risks of taking on privately held college debt. Private student loans aren’t eligible for federal protections like income-driven repayment, administrative forbearance and certain student debt forgiveness programs. Plus, private lenders determine eligibility and interest rates based in part on the applicant’s credit score, issuing more expensive loans to less-creditworthy borrowers.
If you’re considering borrowing additional money to help pay for college, this guide can help you determine if private student loans are worth it.
[Read: Best Private Student Loans.]
Private Student Loans: Are They Always a Bad Idea?
Conventional wisdom cautions against borrowing private student loans in any circumstance, but one-size-fits-all financial advice doesn’t always reflect the reality that so many college-bound families face. While it’s true that, in an ideal world, no American would have a need for private loans, students do borrow them. At public universities, 9% of bachelor’s degree recipients graduated with private student loans, according to College Board’s 2023 Trends in College Pricing report. At private colleges, that number was 13%.
As with all other areas of personal finance, paying for college is highly personal. Families in high cost-of-living areas might earn too much to qualify for need-based federal aid but still have too little saved to cover the cost of college without taking out additional debt. Scholarships are a wonderful resource for those who earn them, but not every student will receive one. Even the most enterprising scholar who works part time and spends two years at a community college while living at home might run out of financing down the line, especially if their credits don’t transfer to their four-year university of choice.
Of course, the general rule still applies: Private student loans should be a last resort after all other federal financial aid and alternative funding sources have been exhausted. And if you’ve reached the point where you’re considering borrowing a private loan, it might be time to ask yourself: “Is this particular university right for me? Is a degree in this field worth the cost? Should I consider going to the in-state public school over the prestigious private college?”
Whether a private student loan is worth it really depends on your definition of “worth it.” After carefully weighing your financial future and your aspirations of higher education, you might come to the conclusion that millions of other students and their families have reached and decide to take out a private student loan. Here’s what you should know to borrow wisely.
Advantages of Private Student Loans
— For borrowers with very good or excellent credit, private student loan interest rates may be lower than those on federal PLUS loans. “Private student loans do not carry the same benefits as federal student loans but may still be a better option than the federal Parent PLUS loan,” says Gail daMota, president of the Education Finance Council, a trade association representing nonprofit organizations in the college financing industry.
— You should be able to find a no-fee private student loan, since many private lenders don’t charge loan origination fees. Meanwhile, federal student loans have a fixed loan fee of 1.057% that’s rolled into the principal balance — and the fee for PLUS loans is much higher at 4.228%. You should still check with the lender to see if it charges a prepayment penalty for paying off the loan early.
— Most private student loan lenders offer prequalification, so you can see your estimated repayment terms and interest rate with a soft credit inquiry. In other words, you’re able to shop around and compare lenders without hurting your credit score. For parents and graduate students, this can help you make an informed decision on whether a private student loan is a more favorable alternative to borrowing a PLUS loan.
Drawbacks of Private Student Loans
— The biggest disadvantage of private student loans is that they don’t qualify for valuable federal loan protections like income-driven repayment plans, hardship programs and most student loan forgiveness options. “If you need to borrow private student loans, remember to exhaust your federal loan options first due to the benefits federal loans provide,” says Rob Williams, managing director of financial planning at investing firm Charles Schwab.
— To qualify for favorable terms on a private student loan — or even to qualify at all — you’ll most likely need the help of a creditworthy co-signer, such as a parent or guardian. Some, but not all, private lenders offer a co-signer release once the borrower has completed a certain number of on-time monthly payments.
— Unlike federal student loans, private student loans require an established credit history. Lenders determine your eligibility, terms and student loan interest rate based in part on your credit score. This also means that all borrowers on the loan will need to submit to a hard credit inquiry. At least one borrower should have a credit score in the mid-600s or higher, but you’ll need an excellent credit score to lock in the lowest rates available.
— Depending on the lender, you may be required to make payments while you’re still in school. “Typically, repayment begins while you’re still in school, but you might have a choice of interest-only repayments or amortized repayments,” Williams says. “If deferment is allowed, interest will continue to accrue, which will increase the amount you will owe.”
[Read: Best Parent Student Loans: Parent PLUS and Private.]
Tips for Borrowing a Private Student Loan Wisely
Consider More Than Just Interest Rates
Most private student loan lenders offer prequalification through a soft credit check so you can see your estimated interest rate, but that doesn’t necessarily guarantee you’ll be approved when you formally apply. “The posted teaser rates are not always what the borrower will receive,” daMota says. You won’t know the exact rate and repayment terms until you fill out an application through the lender.
Additionally, daMota cautions that “the repayment options are not created equal.” Repayment plans, hardship programs and even interest rate discounts will vary from one lender to the next, so be sure to compare these factors to find a balance between affordability and flexibility.
“To the extent possible, students should find out the interest rate they will actually receive, then look to see if the lender offers different repayment plans or deferment, forbearance or forgiveness options,” daMota adds. “Be sure to include nonprofit and state-based student loan lenders when shopping — they often offer the best interest rates with favorable repayment options.”
Build Your Credit Before Applying, but Have a Co-Signer in Mind
Since private lenders determine your eligibility based in part on your creditworthiness, it’s important to take steps to improve your credit score before you apply. You can boost your credit by opening a secured credit card and paying it off on time each month, or by becoming an authorized user on a relative’s credit card account.
If you can’t manage to get your credit score to the mid-600s on your own before you apply, you’ll likely need to enlist the help of a creditworthy co-signer, such as a parent or guardian. Many private student loan lenders offer a co-signer release, which lets you remove the co-signer from the loan after making a certain number of on-time monthly payments — but keep in mind that not all lenders offer this feature.
Applying for a private student loan will trigger a hard credit inquiry, which will have a temporary negative impact on your credit score. If you’re applying with a co-signer, the inquiry will appear on their credit report, too. To minimize the effect on your credit score, the Consumer Financial Protection Bureau recommends completing all of your private student loan applications within a two-week window.
[Read: Best Student Loans Without a Co-Signer.]
Borrow Only What You Need
Federal student loans have an annual and aggregate borrowing limit, which is why many college-bound families turn to private loans in the first place. For private student loans, the loan amount is still capped at the school’s cost of attendance minus other financial aid as determined by your FAFSA application — although lenders may have their own minimum and maximum borrowing amounts.
But just because you can take out the maximum amount you’re approved for doesn’t mean you should. Take a close look at your anticipated expenses to determine exactly how much you need to borrow in order to cover costs. Overborrowing means you’re taking out unnecessary debt and paying interest on money you didn’t actually use to pay for school.
“Reduce nonessential expenses related to room and board,” Williams says. “This might mean sharing the cost of room and board with more roommates, moving further away or moving back in with parents (if close to home). You might (also) look at renting books or buying used books.”
If you’re approved for a private student loan at a certain amount, but you want to borrow less, let the lender know. It’s your debt, and you’re not obligated to borrow the full amount you’re offered.
Plan Ahead to Estimate Your Total College Costs Early
One of the most important steps toward ensuring financial security in college and beyond begins before you even start applying to schools, daMota says. She recommends using the Education Department’s College Scorecard to get a better idea of your potential earnings in a particular field of study compared with the total cost of attending a specific university.
“This may help (students) choose the school and program of study that is best for them,” daMota says. “This will also give them an estimate of the maximum they should borrow for their degree.” You can also learn more about a university’s estimated cost — including tuition, fees, room and board and average financial aid package — at the U.S. News Best Colleges data center. We provide additional information like a school’s acceptance rate, application deadline and financial aid statistics, as well as the typical high school GPA and SAT/ACT scores among admitted students.
No matter which tool you use, you can compare costs among several universities at once to estimate how much you’ll need to borrow. That way, you can plan ahead with plenty of time to find the right financing option for your needs, and perhaps even eliminate the need to borrow student loans altogether.
More from U.S. News
Private Student Loans vs. Federal Student Loans: What’s the Difference?
Private Student Loan Forgiveness Options
How to Get a Low Interest Rate on a Private Student Loan
Are Private Student Loans Worth It? How to Decide originally appeared on usnews.com
