Private Student Loans – The Basics

 

 

What Are Private Student Loans?

 

Private student loans are loans which aren’t guaranteed and approved by any government entity.  Unlike federal student loans, private student loans are made by banks and other financial institutions using their own terms and qualifications.  Like federal student loans, these loans are offered to undergraduate students, graduate students, and parents of students. 

Private loans also feature the benefit of a 6-12 month grace period and often offer higher loan limits than federal loans, so a student has a better chance of all their expenses being covered.  However, these benefits come at the cost of higher interest rate and loan fees as well as less forgiving terms than those of federal loans.  These factors can very well make private loans a more costly option in the end. 

School-Channel vs. Direct-to-Consumer Private Student Loans

 

Private loans most often come in one of two forms; a school-channel loan or a direct-to-consumer loan. 

Direct-to-Consumer Private Student Loans

With the private direct-to-consumer loan, a school is not involved at all.  Instead, the funds are distributed directly to the borrower after it is verified that the borrower, or dependent of the borrower, is enrolled in at a higher education facility.  Direct-to-consumer loans have become popular over the last few years as more lenders add them to their line-up of student loans.

This is due in part to the fact that these loans allow for very quick accessibility to funds, however, they often come with a higher interest rate because of the greater risk the lender is taking.  With no school acting as the middle man it’s solely up to the borrower to manage their loan.

Another consideration to take into account before deciding on this type of loan is that no criteria is needed to determine how much of a financial need the student has or what the funds must be put towards, so the risk of a student over borrowing and spending the financial aid on items other than school is much higher. 

School-Channel Private Student Loans

With a school-channel private loan this risk is not much of a factor because the funds go directly to the school not the borrower.  There is also another key difference.  School-channel loans are certified by the school the student is attending, meaning that the school has approved the loan total as an appropriate amount for covering the cost of college. 

This added security for the lender means school-channel loans are often offered at lower interest rates.

Qualifying and Applying for Alternative Student Loans

 

There are many differences between federally funded student loans and privately funded students loans, and one of the main differences begins with the qualification process.  Unlike federal student loans, those applying for private loans don’t need to complete the Free Application for Federal Student Aid which takes financial need into consideration. 

Rather, private loans eligibility is based on the credit score of the borrower.  Because of this, it is often a good idea for students trying to obtain a loan to have a co-signer.  A co-signer is someone who also enters into the loan serving as a guarantee that they will be responsible for its repayment if the borrower fails to do so.  Lenders take both the borrower and co-signer’s credit scores into account when deciding whether or not to issue a loan. 

For many students who don’t have a credit score, having a parent or relative act as co-signer is the best, sometimes only, way to receive a loan, and will almost assuredly get the borrower a lower interest rate since it’s based on whomever’s credit score is the highest.

 

Interest Rates of a Private Education Loan

 

As mentioned earlier private education loans, also referred to as Alternative Education Loans, carry higher interest rates and fees than those of federal loans.  Whereas federal student loans are offered at a low fixed interest rate, private student loans are like other loans in that the variable interest rate depends on the borrower’s credit and is also tied to LIBOR and PRIME index rate. 

These index rates are representative of how much it cost the lender to borrow money and the interest rates lenders give to borrowers with the best credit, which affects the interest rates offered on a whole.  The amount of the interest rate can also be manipulated depending on whether or not fees for the loan will be paid and how much those up front fees will be.