The best student loans offer students a way to pay for college without the burden of excessive fees and high interest rates.
Federal student loans are designed and regulated to include fair terms that don't take advantage of the borrower. On the other hand, private student loans vary in their terms, and while they are also regulated by the government, some private lenders still get away with predatory practices. Here are some examples of bad student loan terms that should always be avoided.
1. Excessive origination fees
An origination fee is a charge, typically a percentage of the loan amount, for processing a new loan. The fee is intended to cover the lender's cost for underwriting, pulling credit, and verifying documents. Unfortunately, origination fees are unavoidable when it comes to federal student loans. But you should still understand what they are in order to aid in your search for private student loans as they can quickly add to your total student loan debt. Private student loans vary in their fees, so explore lenders that offer loans without origination fees.
2. Extremely high interest rates
The higher your student loan interest rate, the more you will pay over the life of the loan. You should aim for an interest rate below 10%, and beware of student loans with interest rates much higher than that. These will quickly enslave you in a vicious cycle of dedicating your monthly payments solely toward paying off interest instead of making any kind of dent in your principal balance. Compare interest rates from a variety of lenders to choose a loan with as low of an interest rate as possible.
3. Prepayment fees
A prepayment fee is a charge assessed by the lender for paying your loan off early. This is an illegal practice within the student loan industry. All student loan lenders must allow penalty-free prepayment. However, some lenders are very misleading in their terms. If a lender is claiming it charges you a fee for paying off your student loans early, it's dishonest and should be avoided regardless of any other benefits it may be offering.
4. Inflexible repayment plans
Avoid lenders that only offer one rigid repayment plan. It might not seem like a big deal now, but you run the risk of not being able to afford the monthly payment upon graduating. Look for lenders that offer flexibility to their repayment plans. Ideally, they should have options in place for people experiencing economic hardship or folks with low income. These may be presented in the form of deferment options or hardship waivers. This shows they will be more willing to work with you if you ever run into issues with being able to meet your financial obligations in the future.
5. Collection charges
A collection charge is a penalty fee the lender may charge for missing consecutive monthly payments. These fees may be unavoidable and can be upwards of 16% of the borrower's outstanding loan balance and accrued interest charges, which is an astronomical amount if you have even a modest student loan balance. Each lender determines their fees, so make sure you know what potential collection fees may be assessed and that they aren't unreasonably high before signing for a student loan.
6. Variable interest rates
With a variable interest rate, the lender can change the interest rate on your loan at will. This means they have the ability to increase your interest rate to an unaffordable rate at any time. Although a variable interest rate isn't always a negative scenario, as they often come with lower interest rates at the time of signing than their fixed-rate counterparts, many people find that fixed interest rates are better for long-term loans like student loans. You should always research the company to ensure you are doing business with a reputable lender. This may help indicate the lender will be less likely to implement exploitative rate increases in the future.
7. Secured student loans
Some lenders offer secured student loans, meaning you offer up an asset as collateral in order to guarantee the loan. If you fail to make your required payments, you risk losing your asset. Student loans should never be secured. If a lender asks for collateral, avoid it at all costs.
Even though the student loan industry is highly regulated, there are still private lenders that provide predatory loan terms. Do your research and compare loans to ensure you are receiving the best terms available.