How Do Private Student Loans Work?

Updated August 12, 2022

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Around 43.2 million Americans borrow money for college, according to About 70% of college students graduate with debt. College student loan debt averages nearly $40,000 per learner.

Federal student loans account for nearly 93% of the nation's student loan debt. Learners also take out private loans. So, how do student loans work? This page explains private student loans, including how they work and how to apply for one. You can also explore the pros and cons of private student loans.

All About College Tuition and Student Loans

As of August 2021, the average cost of college is $35,720 per year. Tuition varies by school and location. In-state learners at public institutions pay the most affordable tuition. Private institutions usually charge the highest tuition.

Students at four-year colleges pay an annual tuition that ranges from $10,560-$37,650, according to the College Board. However, college costs include more than tuition. Enrollees should also budget for housing and transportation costs.

Most students rely on some financial aid to pay for college. As of August 2021, college students use financial aid for 92% of their college costs. About 71% of students rely on federal financial aid. This may include grants, loans, and work study.

So, how do student loans work? Federal loans usually offer lower interest rates than private loans. Individuals with good credit may qualify for low-interest private loans. Keep in mind that private loan interest that accrues during school may get added to the principal balance. Students should apply for scholarships, grants, and federal loans before taking out private loans.

What Are Private Students Loans?

These loans are best for learners who have exhausted their federal loan options. Some common private student loan lenders include Sallie Mae, CollegeAve, and Discover Student Loans. Other choices include EDvestinU, Ascent, and INvested.

How Are Private Loans Different from Federal Loans?

Federal student loans come from the government. Private loans come from credit unions, banks, and state organizations. Federal loans feature terms and conditions determined by law. Private student lenders set their own terms and conditions.

Federal student loans usually cost less and offer special benefits. These include low, fixed interest rates and income-driven repayment plans. Private loan applications require a credit check while federal student loans do not. Borrowers can consolidate federal loans but not private loans.

Types of Private Student Loans

Several private student loan types are available, including degree-specific loans. Some special loans serve international students. Others serve students without good credit. These borrowers may have trouble getting credit approval for traditional private loans. Some college students qualify for state-specific loan programs that receive funding from state agencies.

Income-share agreements adjust repayment rates based on the borrower's income after graduation. Some families take out private parent loans. These loans hold the parent financially responsible for repaying the loan.

How Do Private Student Loans Work?

Applying for Private Loans

When it comes to applying, how do student loans work? What do private loans require from borrowers? Most private lenders seek borrowers (or co-signers) with good credit scores and steady incomes. Undergraduate applicants usually need co-signers to receive private loans. Most private parent loans do not permit co-signers. Lenders such as SoFi only provide loans to U.S. citizens.

Applicants complete loan applications and co-signer information. They also provide proof of identity, enrollment status, and sufficient income. Many private lenders accept applications at any time of year.

How Do Private Loan Interest Rates Work?

Private loan interest rates depend on the lender, borrower, and market factors. Many private lenders offer lower interest rates to applicants with good credit and viable income. Niche lenders serving borrowers with poor credit often charge higher interest rates.

Some loans feature fixed interest rates that remain static. Other loans offer variable rates that may change monthly or quarterly based on market fluctuations. Borrowers should compare loan interest rates carefully to identify the most affordable option.

Credible, a platform that helps potential borrowers compare private loan interest rates, cites a 0.99%-11.98% range in variable interest rates and a 2.99%-12.99% range for fixed interest rates.

How Much Should You Borrow?

Minimum and maximum loan amounts differ by lender. Some loans start at around $5,000 and cover up to 100% of school-certified attendance costs. These costs include housing, tuition, and personal expenses. Borrowers should consider loan length, interest rates, and expected income when deciding how much to borrow.

Many learners avoid borrowing too much by choosing more affordable schools. Students can also explore other financial aid options. Some learners enroll part time so they can continue earning an income.

Private Loan Repayment Plans

Most borrowers can choose from several private student loan repayment options. Many full-time learners prefer private loans that allow repayment after graduation. Some students want to start repaying their loans while in school. They can choose from immediate repayment, interest-only repayment, or partial repayment plans.

Immediate repayment plans require borrowers to start paying the principal loan and interest right away. Many students choose interest-only payment plans. These allow borrowers to make interest payments while in school. This keeps interest from accumulating on the principal balance and accruing additional interest later. Some lenders offer fixed, partial monthly repayment options while in school.

Should You Get a Private Student Loan?

Federal loans cost less than private loans. They also offer more financial benefits. However, private loans come with both benefits and disadvantages. See below for some private loan pros and cons.

The Pros

Private loans offer several advantages over federal loans, including no origination fees or borrowing limits. Federal loans cap undergraduate loans at $12,500 annually and $57,500 total. Private lenders do not limit loan amounts for those with good credit.

Private loan applicants with good credit may qualify for interest rates below the 6.28% rate of PLUS loans. However, direct federal loans offer the lowest interest rates. Borrowers can take out private loans at any time. The government only dispenses federal loans at certain times.

The Cons

Private loans come with higher interest rates than federal student loans. Many private loans begin accruing interest immediately. Federal loans start gathering interest after graduation. Unlike federal loans, private loans do not typically offer programs for loan deferral, forbearance, or forgiveness.

Applicants pursuing private student loans need positive credit histories, sufficient income, or viable co-signers. Federal loans do not require good credit.

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