Private student loans are always a sensitive topic. There is a group of people who believe that private student loans are terrible tools and that no one should take them out to pay for college. On the other hand, there are banks and refinancing companies that promote private student loans as a less expensive alternative to federal student loans.
As a parent or potential borrower, what is it? It’s a tough question and there’s no right or wrong answer. Scratch that – there are some wrong answers and situations when private student loans never make sense. However, there are also scenarios where private student loans make sense. But how do private student loans work?
We’ll break down everything you need to know about how private student loans work to pay for college. From how it works to what you need to know about repayment, we cover it all.
Now is the time every student and parent dreads – having to write that check for college. It’s expensive. There’s no denying that. When it comes to discussing how to pay for school, the issue of private student loans inevitably comes up.
If you don’t know where to start, federal or private loans, check out this guide to find the best student loan rates.
Private student loans are loans that are used to pay for education and related expenses. They are issued by banks, corporations and credit unions – not the government. Private student loans are closer to a car loan or mortgage than any other type of debt.
This may seem shocking, but when you think about it, it makes sense. When you take out a car loan and fail to repay it, the bank repossesses your car. If you buy a house with a mortgage and don’t make your payments, the bank will foreclose on your house.
Well, a private student loan is backed by your earnings – and the guarantee is what you’ll earn in the future. The bank is willing to loan you this money for college, because statistically a college degree enhances income potential. As such, you need to be aware that if you fail to repay your private student loans, your lender can garnish your wages and more.
However, what makes student loans different from other types of debt is that, unlike credit cards or car loans, they typically cannot be discharged in bankruptcy. As long as you have the ability to earn income and pay it back, a bankruptcy judge will not erase your student loan debt.
Key terms and “need to know”
Private student loans are loans, and you are borrowing this money and will have to pay it back. as, You need to know exactly what type of agreement you are going to enter into. When considering a private student loan, here are the key terms you need to consider.
interest rate: The interest rate is the rate at which interest will accrue on your loan. The lower the interest rate, the less “extra” you will have to pay to borrow this money. For example, if your interest rate is 1% and you borrow $1,000, you will pay $10 per year to borrow that money (this is an oversimplification, but it works). The interest rate is one of the primary factors you should consider when taking out a student loan. The lowest interest rate is usually always the best loan.
condition: The term is the duration of the loan. Many private loans have standard terms, such as 10, 15 or 20 years. Different lenders offer different options. Combined with your interest rate, this term really determines how much you’ll pay monthly. The longer the term of the loan, the lower your monthly payments typically will be.
expenses: Some loans charge a loan processing fee. You really need to read this carefully – they can be called origination fees, processing fees, document fees, and more. Many of the best lenders don’t charge any fees to take out a private student loan, so if you see a fee, you’ll probably want to run.
the site: Some special loans will require the cosigner to qualify for the best interest rate. The reason for this is that most lenders rely on traditional credit score models for lending – such as credit history and credit score. As someone going to college, you probably don’t have much of a credit history. Lenders may then ask you to have someone co-sign for the loan. A joint signature means that this person He’s just an official like you To pay off the debt. If you don’t pay, the lender can go after the cosigner to get them to pay.
As such, you should really be careful when getting a co-signer, and realize that many people feel wary of being a co-signer for this reason. Some loans allow the cosigner to be released, usually after the borrower has made a set number of on-time payments (usually 3 years or more).
Related to: There are no private student loans without a Cosigner but they are limited in their offerings.
Other benefits of private student loans
Many lenders offer two types of benefits for their student loans. I will break it down into repayment interest and other interest.
For repayment benefits, you can look for lenders that offer discounts for setting up automatic payments or paperless statements. Some lenders now offer an interest rate reduction of about 0.25% simply for setting up automatic payments.
Some new lenders now offer other benefits, such as employment assistance if you lose your job, and more. These are just additional perks, and should not factor into your decision about whether or not to take out private student loans.
How to qualify for a private student loan
Now that you know the basic terms and how private student loans work, you may be wondering how you qualify for a loan. Since private student loans work very similarly to other types of loans, the qualification process is similar as well.
While each bank and lender uses different criteria, most require borrowers to:
Credit score is key. Having a great credit score usually means you’ll easily qualify for a private student loan. If your credit score is below 700, you will have problems. If your credit score is below 650, you may be out of luck.
We recommend using Credit Karma as a free tool to check your credit score – Go do it now.
The second factor, which is closely related to your credit score, is having a co-signer for your student loan. If you are close to meeting the bank’s criteria for a loan, they may require you to have a co-signer. This is usually a parent, but it could be anyone really. I would say the majority of student loans are processed with a co-signer. Just remember that the cosigner is just as responsible for the loan as you are.
When to Consider Private Student Loans for College
Now that you know all about how a private student loan works, you probably want to know whether or not you should consider it. The answer is maybe.
Private loans can serve a great purpose of helping pay for school if you can’t afford it. But before you jump on the bandwagon, you should do two things.
First, you should always do an ROI calculation to see if the cost of college is worth it. It’s sad to think about, but you’re actually getting this education to enhance your profits, and if you don’t, you’ve wasted your money. Plus, you’ll definitely need that higher income to pay off your loans!
When doing the math, I like to keep it simple – Figure out what career you want, find the starting salary for it, and never borrow more than the starting salary for the job you want.
For example, if you want to become a teacher, that’s great. But you shouldn’t borrow more than $35,000, because that’s the average amount teachers get after graduation.
If you want to become an engineer, you should not borrow more than $64,000, because that is the basic salary of an engineer today.
Second, you must exhaust all federal borrowing options first. Federal student loans are great tools to pay for college. They typically offer better interest rates, payment plans, and forgiveness options.
We detail the full amounts you can borrow and the types of loans offered in our ultimate guide to student loan debt. Since this article is about private loans, we won’t delve too deeply into federal student loans. Just realize that you should max out first before considering a private student loan.
Scenario in which private student loans make sense
Now that you’re thinking about taking out a private student loan, I want to share with you the most common scenario when private student loans make sense.
It’s the scenario of going to medical school. We’ve talked about student loan options for doctors before, but let’s look at a scenario for private loans.
Going to medical school is expensive—doctors can expect to spend $180,000 or more on school. But doctors can also make a lot of money after graduation.
Let’s look at our rules. The first rule is that you should consider the salary after graduation. For doctors, after they become residents, they can expect to earn $200,000 or more. This is a great salary and means they can handle a significant amount of student loan debt.
What about federal loans? Well, doctors should definitely max out their federal student loans. The problem is that federal loans allow you to borrow a maximum of $20,500 per year — and doctors may need more.
In this scenario, private student loans make a lot of sense to bridge the gap between tuition and where federal loans go. Furthermore, there are lenders who specialize in lending to doctors and lawyers, due to the uniqueness of their situations.
How to Shop for a Private Student Loan
If you decide that private student loans are right for you, it’s essential that you shop around for the best loan.
When shopping for a loan, interest rate and term should be your #1 and #2 priorities.
I suggest you start in two places when it comes to shopping for a private student loan. First, check with your school’s financial aid office. Some schools have preferred lenders, who offer discounted interest rates and terms to their students. This can provide significant savings.
Then look at our guide: Best Private Student Loans >>
Also, you should take a look at a comparison engine like Credible. Credible will shop multiple lenders at once and provide you with the best interest rate and fees for your situation. You can also compare all major student loan lenders via our student loan tool.
The key here is shopping. Don’t just make one loan because someone asked you to. Look for the best loan because it may be difficult to change later.
Pay off private student loans
If you have private student loans, you need to understand how to repay them. We’ve already discussed the basics earlier, but let’s take a look at what to do when it comes to paying off your student loans.
Unlike federal loans, there aren’t many options for repaying your own loans. If you can’t afford your private student loan payments, your only option is to try to refinance the loan over the long term so that your payments are lower.
Some private lenders offer deferrals based on your situation, but this is very rare for private student loans.
conclusion
Private student loans should be viewed like any other financial instrument. They serve a purpose, but often they are used in the wrong way.
As such, if you are considering private student loans, be sure to follow the steps above. Get federal loans first, then private loans. Always make sure you shop around for the best interest rate and fees.
Remember, you can compare a range of different lenders at once using a service like Credible.
Do you have private student loans? Do you think about them?
