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Why Are Private Loans Such a Bad Choice for College Students?

By Maurie Backman – Mar 1, 2020 at 8:00AM

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Here's why you're generally better off avoiding private loans to fund your education.

Given how expensive college is these days, many students have no choice but to borrow money to fund their degrees. If that's the route you're planning to take, you should know that not all student loans are created equal -- and that borrowing privately for college is a move that you may end up regretting.

Two major problems with private student loans

When it comes to borrowing for college, you have two choices -- you can take out federal student loans, which the U.S. Department of Education oversees, or you can take out private loans, which aren't regulated by a government agency. Here's why private loans may not be your best choice.

A college student passed out with his head on his textbook.

Image source: Getty Images

1. They typically offer less favorable interest rates than federal loans

The higher the interest rate attached to your student loans, the more that debt will cost you to pay off. Federal student loan interest is capped at preset rates. Federal Direct Subsidized Loans and Direct Unsubsidized Loans have a fixed rate of 4.53% for loans disbursed in mid-2019 through mid-2020. But with private loans, you could easily be looking at double the interest. 

Furthermore, federal loans have a fixed interest rate, so you don't have to worry about that rate climbing during your repayment period. Private student loan interest can be variable, which means that while you may start out paying 8% or 9% interest per year, that figure could rise to 10% or 11%, thereby driving up your payments. 

Of course, one caveat here is that private lenders do take your credit score into account when determining what interest rate you qualify for. If you have a good credit score, you may be able to snag a competitive rate that's comparable to what you'd pay on a federal loan. But if your credit isn't superb, there's a good chance private loans will cost you more than federal loans. 

2. They don't offer borrower protections

If you take out federal student loans and start to struggle with your repayments, you have options at your disposal. You can apply for an income-driven repayment plan so your monthly payments are recalculated as a reasonable percentage of your earnings. You can even apply to defer your payments for a period of time if you're undergoing a financial hardship. 

Private student loans don't come with these same protections. If you find that you can't make your monthly payments to the point where you default on your student debt, your lender could get a court order to garnish your wages, thereby making an already tough financial situation even worse for you. 

That said, some private lenders do cut borrowers a break when they wind up struggling with their payments, either by agreeing to lower their interest rate or letting them defer payments for a bit. But technically, private lenders aren't obligated to offer these options, so that's something you'll need to take into account when applying for loans. 

Be careful when borrowing privately for college

Generally speaking, your best bet is to exhaust your federal borrowing options before resorting to private student loans. If you only qualify for a certain amount of federal aid and you need more money to cover your education costs, then private loans may be your best, or only, fallback option. But if you're going to borrow privately, read the loan terms very carefully so you know what you're signing up for.

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