What Is a Private Student Loan?

Q: What is a private student loan? Are private student loans bad?

A: Private student loans are not necessarily bad, but these loans can be expensive and therefore should be considered very carefully. However, private student loans can be a good deal if you or your cosigner has excellent credit. In fact, in some cases, private student loans can offer better interest rates than federal loans. 

Private student loans, unlike federal student loans are offered by banks and other lending institutions. These loans are meant to be used after you have taken full advantage of all your free financial aid and federal aid options.

In addition, there are different types of private loans: Private loans that must be certified (or approved) by your school of attendance, and private loans that do not need to be certified by the school.

Certified private loans are usually less expensive and the loan funds go to your school. After your expenses are paid, any left over funds are given back to you by the school.

Non-certified private loans are more expensive and the loan funds can come straight to you. These are the most expensive student loans available and should be avoided if possible.

But regardless of these options, you should always consider your federal student aid options BEFORE considering any private loan.

What is a federal student loan?
A federal student loan allows students and their parents to borrow money to help pay for college through loan programs supported by the federal government. They usually have low interest rates and offer attractive repayment terms, benefits and options. Generally, repayment of a federal loan does not begin until after the student leaves school. Federal student loans can be used to pay school expenses such as tuition and fees, room and board, books, supplies and transportation.

Federal student loans are delivered to students through two programs: the Direct Loan Program and the Federal Family Education Loan Program. Both programs offer essentially the same type of loans with similar loan terms and borrower benefits. Your school chooses the loan program in which it will participate. In both programs, loan funds are provided to you through your school.

What is a private student loan?
A private student loan is a nonfederal loan issued by a lender such as a bank or credit union. Private student loans often offer fixed or variable interest rates, require a credit check and do not provide the repayment protections of federal student loans.

Why are federal student loans a better option for paying for college?
Federal student loans offer borrowers many benefits not typically found in private loans. These include low fixed interest rates, income-based repayment plans, loan forgiveness and deferment options, including deferment of loan payments when a student returns to school. For these reasons, students and parents should always exhaust federal student loan options before considering a private loan.

How do I get a federal student loan?
To get a federal student loan, you must complete the Free Application for Federal Student Aid (FAFSA). The easiest way to complete the FAFSA is online at www.fafsa.ed.gov. Here, you identify schools that you are interested in attending. When your FAFSA is processed, the schools you have identified will receive your information. The school will then tell you how much financial aid is available, including grants, scholarships, work opportunities and federal student loans. Should you choose a federal student loan, your school will provide you with instructions on next steps, including how to select a lender.

How much money can I borrow in federal student loans?
Undergraduate student loan limits range from $3,500 to $10,500 per year depending on certain factors, including the year in college. Graduate students can borrow up to $20,500 each year. Parents can also get federal student loans to help pay the remainder of college costs that are not covered by other financial aid. These are called PLUS loans. In addition, graduate students may obtain PLUS loans to help pay for their own education.

Why should I complete a FAFSA when the private loan application process may be easier?
While the application process may be easier in some instances, federal student loans usually have lower interest rates and better repayment terms and options than private student loans. Additionally, schools use the information provided on the FAFSA to determine eligibility for other types of financial aid provided by the federal government, from your state, or from the school itself. This aid can include grants, scholarships and work opportunities.

What kinds of federal student loans are available?
Stafford loans are for undergraduate and graduate students. There are two types of Stafford loans: subsidized and unsubsidized.

• Subsidized Stafford loans provide low interest rates and are available to students who demonstrate financial need based on income and other information provided on the FAFSA. A credit check is not required to receive these loans. The federal government pays the interest on these loans until six months after the student is no longer enrolled in school at least half time.

• Unsubsidized Stafford loans provide low interest rates and are available to all students regardless of financial need (although the FAFSA still must be filed). A credit check is not required to receive these loans. The student is responsible for the interest, which may be paid while the student is in school or accrued and then added to the principal balance when the student enters repayment, which occurs six months after the student is no longer enrolled in school at least half time.

PLUS Loans are low interest loans that parents can obtain to help pay the cost of education for their children. In addition, graduate students may obtain PLUS loans to help pay for their own education. PLUS loans require a credit check and, in some instances, an eligible cosigner. Repayment of PLUS loans begins following the final disbursement for the year. Graduate students may be able to defer repayment of their PLUS loans until after the student is no longer enrolled in school at least half time, although interest will continue to accrue.

Consolidation Loans allow student or parent borrowers to combine multiple federal student loans into one loan with one monthly payment. Some private lenders may offer consolidation loans. Borrowers should be aware that they will lose their federal borrower benefits if they consolidate their federal student loan into a private consolidation loan. 

Which Student Loan Is Best?