Private Student Loans: Know These Risks Before You Borrow


While the term “student loan” is often used to describe any type of graduate student debt, there are two distinct types of loans that have their fair share of differences: federal student loans and private student loans. Both carry some risk, but private loans lack many of the protections and benefits available with federal loans.

If, like about half of undergraduates, you need to borrow to pay for your education, you need to use federal loans first. But if you’ve already borrowed the maximum amount available from the federal government, you might consider turning to a private student loan to cover the rest of your bills. Here’s what to consider before signing the dotted line:

Private loans do not allow payments based on your income

Income-based repayment protects against one of college’s biggest risks – it’s hard to know for sure that enrollment will lead to higher income. It is true, on average, sure. But not for every individual. So, when repaying federal student loans, borrowers have the option of signing up for an income-based repayment plan, which is not available for private loans. This benefit allows you to make a monthly payment based on a percentage of your income and your family size.

Reducing your monthly payments with an income-based repayment can help if you lose your job or don’t earn enough to pay all of your bills. Then, after 20 or 25 years of monthly payments (depending on the plan to which you subscribe), the balance of the debt is canceled. But keep in mind that whatever balance is written off is considered taxable income.

Private loans have no option for student loan cancellation

Unlike federal student loans, private student loans do not have the potential to be forgiven other than filing for bankruptcy. (And that presents its own challenges.)

But with federal student loans, those pursuing careers in certain areas of the public service, such as a teacher or librarian, may have their loans canceled after 120 qualifying payments. Private loans are not eligible for this public service loan forgiveness program.

Federal loans offer other options for paying off student loans, like a closed school dump, which some private lenders don’t. And private lenders also don’t offer the forgiveness associated with the income-driven repayment plans described above.

There are no subsidized private loans

There are two types of federal student loans: subsidized and unsubsidized.

Subsidized loans are better because the government pays the interest on them during periods of adjournment. So, those four (or more) years that you’re in college? You will have a deferral of tuition and no interest will accumulate, which means that your loans will not increase, as long as you are enrolled at least part-time. The same goes for other periods of deferment, such as deferment of unemployment.

Subsidized loans are given to students with financial need. They represent about a third of federal student loans outstanding for undergraduates. The rest aren’t subsidized, which means they start earning interest as soon as you take it out. This is how private loans work, except they also tend to have higher interest rates than federal loans.

Private loans have limited options for suspending payments

Private lenders are not as flexible if you lose your job or have other financial difficulties. With federal loans, you can defer your payments until your situation improves relatively easily through forbearance or deferral. For example, you can request a deferral of unemployment or a deferral of economic hardship and, if approved, have your loans deferred for up to three years.

There are private lenders that allow you to forbear loans, but generally federal loans have a longer option on this. And with federal subsidized loans, carry-overs can be an interest-free carry-over, which never happens with private loans.

Private loans have no fixed borrowing limits

Federal student loans have limits on how much a student can borrow each year. The limit for undergraduate students, for example, is $ 5,500 for dependent students and $ 9,500 for independent students.

But with private loans, lenders determine how much you can borrow based on your creditworthiness. Without clear limits, it can be tempting to borrow more than is absolutely necessary or mistakenly borrow an unaffordable amount for an entry-level salary. Students (and parents) should borrow as little as possible to get college loans, but this is especially true for private loans, which carry higher interest rates.

Private loans can ruin a student’s credit AND a co-signer

Most private loan borrowers must have a co-signer to be approved. Since many students have little or no credit and no stable income, a parent or other family member often co-signs. The problem is, co-signing a loan is essentially borrowing the loan yourself. A co-signer is just as responsible for repaying the loan as the student who uses it to go to college.

So, if a borrower can’t land a job after graduation or collapses on repayment, the co-signer should foot the bill. This loan will follow the co-signer – on their credit report, at least – until they are fully paid off. There are a handful of private lenders who offer co-signer release. This means that the co-signer can be released from the loan obligation if a borrower meets certain requirements (such as making a specific number of payments on time), but this is not a guaranteed benefit.

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