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Most students first look to grants, scholarships, and federal student loans to finance their higher education. But for millions of young adults, this isn't enough to cover the full cost of their school's tuition, so they turn to private student loans.
These are student loans issued by private banks instead of the federal government. Unlike federal student loans, which offer the same interest rates and terms to every student borrower, private student loan terms vary from one company to the next. Here's a closer look at the factors you should consider when choosing a private student loan lender.
Interest rates
Interest rates are a major concern with any loan because they affect how quickly your balance grows, and how much you pay overall. Federal student loans offer the same interest rates to all student borrowers, but private student loan lenders base your rates on your creditworthiness.
It's common for lenders to advertise their lowest interest rate, but only those applicants with the best credit (or a co-signer who has excellent credit) will actually receive that rate. Yours may be higher. Some companies allow you to learn whether you prequalify for a private student loan and check their website to see what your interest rate would be. For others, you may have to submit an application to find out what a lender may offer you.
Interest rates can vary from less than 5% to more than 12%, depending on the lender and your credit. It's best to compare the rates of a few private student loan lenders before you decide, so you know you're getting the best deal.
Try to submit your applications within a month of each other if you can. Lenders will do a hard inquiry on your credit report and this can drop your credit score by a few points. But credit-scoring models consider all credit inquiries that take place within a 30-day period to be a single inquiry that accounts for normal credit shopping behavior.
Fees
Some private student loans charge origination fees, which help cover the costs of processing the loan. This is usually a percentage of your total loan amount, and it's built right into your loan balance. That means you won't actually get the full amount you're requesting to put toward your college expenses because the lender makes sure it gets paid first. Not all private student loan lenders charge origination fees, but if yours does, the amount you pay will be determined by how much you’re borrowing, and by your creditworthiness.
Private student loans may also charge fees for:
- Late payments
- Returned payments
- Defaulting on your student loan
- Putting your loan into deferment or forbearance
- Paying your student loan off early
Before you agree to the loan terms, ask the lender for a copy of their fee schedule and look it over. An origination fee and a late payment fee shouldn't raise too many alarm bells, but if the company tries to nickel-and-dime you for every little thing, you're better off staying away from that lender. Then, just as you have for the interest rates, compare the fee schedules from multiple private student loan lenders when assessing which one offers the most affordable loans.
Co-signer requirement
Many private student loan lenders require student borrowers to have a co-signer. Young adults often don't have much of a credit history of their own, and this can leave lenders in the dark about how they'll manage their money. If they can't keep up with the payments, lenders could lose money, so they require a co-signer -- often a parent, but it could be anyone -- who's willing to vouch for the student's reliability and take over the payments if the student is unable to.
A few lenders may permit you to take out a private student loan without a co-signer, but you'll probably pay a higher interest rate to reflect the increased risk to lenders. If you're trying to keep costs low, you're better off cosigning with someone who has a good, established credit history, if possible.
If your co-signer is wary about being on the hook for your student loans, look for a private student loan lender that offers co-signer release. Each lender has its own terms you must meet to qualify. In most cases, you must have a high enough credit score when you request your release, and must have made a certain number of on-time student loan payments. Some lenders may also have income requirements. Check into the co-signer release policy if you are interested in pursuing this.
Repayment terms
Private student loans aren't known for their flexible or generous repayment terms. When you're still in school, your options may consist of making fixed monthly payments, making interest-only payments (to prevent your balance from ballooning), or deferring payments altogether. But once you leave school, you typically have no choice but to pay the fixed monthly amount.
There are no income-driven repayment plans that tie your monthly student loan payments to your earnings, like those that the federal government offers. This may increase your risk of defaulting, which can hurt your credit, and make it difficult to secure new loans in the future.
Ask the lender how much your monthly payments will be before you agree to the student loan's terms, and make sure you're comfortable paying this amount. You should also find out whether the loan offers any alternative repayment plans to borrowers who cannot keep up with its standard repayment plan. If you do fall behind on your payments in the future, reach out to your lender and discuss your options.
Deferments and forbearances
Deferments and forbearances can both temporarily halt your student loan payments without the risks of late payment fees or having to default. Typically, you must meet certain criteria in order to be eligible for a deferment, while forbearances are at the discretion of the lender. A forbearance is usually allowed for no longer than 12 months, while a deferment may be allowed for longer, depending on what your lender permits. In both cases, your balance will continue to accrue interest unless you're paying at least enough to cover each month’s interest charges.
Many lenders offer deferments to students while they're still enrolled at a qualifying university, while others offer deferments or forbearances to those who experience financial hardships after graduation. But every lender is different, and some may not offer any deferment or forbearance options at all.
You may think you won't need to use them, but if you struggle to get a job after graduation, a deferment could help keep you out of default. Check with your private student loan lender to see if it offers any opportunities for deferments or forbearances, and what qualifications you must meet in order to be approved for them.
Look at the whole picture
Many students focus solely on price when choosing a private student loan lender, but if that lender doesn't offer flexible repayment terms, deferments, or a co-signer release, you or your co-signer could end up in financial trouble if you're unable to afford your monthly payments. You may be better off paying a little more to work with a private student loan lender that offers greater flexibility to borrowers, but that's for you to decide.
Consider which of the above factors are the most important to you, and focus on these first when choosing a private student loan lender. Don't hesitate to ask the lender any questions you may have about its services or fees. If it cannot give you a clear answer or seems evasive, you probably want to stay away from it. Don't sign on the dotted line until you know exactly what you're getting.