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If you need a student loan for college, your first choice should probably be federal loans, with their relatively low interest rates and flexible repayment plans. But you might also need private student loans. Before borrowing, be sure to consider the pros and cons of student loans from private lenders.
Pros and Cons of Student Loans from a Private Lender
When it comes to private student loans, sometimes referred to as âalternative student loans,â there are both pros and cons to be aware of. Let’s take a look at some of these pros and cons, so that you can fully understand what it means to borrow a private student loan for school.
1. Pro: Rewards for great credit
With most types of federal student loans, your credit doesn’t matter. Your the interest rate is set by Congress; everyone has the same rate, regardless of the credit.
With private student loans, however, you can be rewarded if you have (or your co-signer has) excellent credit. As of the posting date, you can find rates starting below 3.4%. Current federal student loan rates are lower for undergraduates at 2.75%, but higher for graduate students at 4.3% for unsubsidized direct loans or 5.3% for grad PLUS loans .
2. Advantages: higher borrowing limits
In many cases, alternative student loans come with higher borrowing limits than federal debt. If you go to a expensive school, you may not be able to get the amount you need if you are relying solely on federal student loans.
With Federal Student Loans, your total borrowed amount cannot exceed $ 31,000 as an undergraduate dependent or $ 57,500 as an independent undergraduate. For graduate student loans, the limit is $ 138,500, including what you have already received as an undergraduate student.
Depending on your level of education, you can borrow up to 100% of your tuition with alternative student loans. If you’re experiencing a âfunding gapâ because federal student loan limits restrict you, private student loans are one way to make up the difference.
3. For: Limitation period
When you By default on your federal student loans, there is no statute of limitations. No matter what is going on or how long your debt is overdue, eventually you will need to pay off your loans. Your wages and tax refunds can even be garnished for your federal student loan debt.
One of the main advantages of alternative student loans, however, is that there is a statute of limitations on default. The statute of limitations varies by state, ranging from three to 10 years. After this time, lenders have few options to recover from you.
While student loan defaults are bad for your credit and are rarely advised, it can be comforting to know that there is an expiration date for private student loan defaults should the worst happen.
4. Disadvantage: Ineligible for income-tested rebate or federal rebate
With Federal Student Loans, You Can Turn To income-based repayment plans if you’re having trouble paying your monthly payments. These plans cap your loan payments at a small percentage of your income. Private student loans are not eligible for these plans.
While some private lenders offer options for financial hardship like deferral or forbearance, it’s not the same as capping your regular payment to a percentage of your income. On top of that, if you use private student loans, they will not be eligible for federal forgiveness programs such as Public Service Loan Forgiveness (PSLF).
That said, you may be able to find a loan repayment assistance program from your state or employer that will help you pay off private student debt.
5. Disadvantage: interest rates can be variable
While some alternative student loans also offer fixed rates, this is not always the case. Instead, you could end up with a variable rate.
If interest rates rise over time, so will your variable interest rate, along with your monthly payment. The hybrid rates advertised by private lenders are a mix of 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.
6. Against: No federal subsidy
Depending on your loan type, some federal student loans have a interest subsidy. If your debt qualifies, the government will pay your interest while you are in school or even in repayment. Interest won’t accumulate, saving you hundreds or thousands of dollars on your debt.
One of the disadvantages of private student loans is that this option does not exist. Interest starts accruing from day one, and in some cases you may need to pay interest while you are still in school. If you don’t pay the interest as you go, it will all add up to your debt when you graduate.
7. Disadvantage: a co-signer may be necessary
Although most federal student loans do not need a co-signer, you might need one for your private student loans even if you have good credit. After all, you might not be working and earning an income while you’re enrolled.
A co-signer is legally responsible for your debt if you are unable to pay it off. If you miss a payment – or worse, fail to repay your loans – your co-signerâs credit will be damaged and collectors can sue them for payment.
8. Disadvantage: private debt is not always paid after death
Federal loans are canceled if the borrower dies. The debt will be cleared and will not be deducted from your estate.
With private student loans, however, lenders might try to recover your estate in the event of death. While private student lenders can’t collect from parents if the debt isn’t co-signed, they can still reduce the value of the inheritance you leave behind.
In addition, some private loans automatically default if your co-signer dies, even though you have kept your payments.
Start with federal student loans when possible
While alternative student loans have some advantages, the reality is that many students are better off starting out with federal student loans.
When funding your education, start by using your savings and apply for scholarships. Then turn to federal student loans. Federal debt comes with flexible repayment options and protections that could save your financial life in the future.
Turn to private student loans when you can’t meet your funding gap in other ways. Even with federal grants and loans, you may still need a private student loan to pay for your education.
If so, make sure you understand the pros and cons of student loans from a private lender before you borrow. Once you’ve done that, shop around and compare your options to find a loan with the best rate and terms for you.
Rebecca Safier and AndrÃ© Pentis contributed to this report.