Everything You Need to Know About Private Student Loans

Americans currently owe more than $150 billion on private student loans, according to the Consumer Financial Protection Bureau. Unfortunately, many private loan borrowers don’t understand the difference between private and federal loans. And that can run them into serious trouble down the road.

So before you sign up for any private student loans, make sure you know everything you should about this option.

They’re Not the Same as Federal Student Loans

Private loans can vary widely from lender to lender, and are very different from federal loans, which are more uniform. Here are the major differences between private and federal student loans:

Federal student loans don’t have to be repaid as long as you’re in school at least half-time. Private loans, on the other hand, may require payment immediately, though this depends on the lender. Always read the fine print, and always make sure you understand the terms.
Federal student loans have a fixed interest rate. Private loans can have a variable interest rate, and can be quite high.
Federal student loans don’t require a credit check (except for PLUS loans). Private loans often require established credit, which means you may need a co-signer.
Interest on some federal loans is tax deductible, whereas interest on private loans may not be tax deductible.
Federal loans can be consolidated through a Direct Consolidation Loan, but private student loans don’t qualify.
Federal student loans offer many payment options, including forbearance and deferment, but private loans may not.
Federal student loans can sometimes be forgiven through loan forgiveness programs. Private student loans are rarely, if ever, forgiven.

They Should Usually Be Your Second Choice

The vast majority of students will get a better deal if they opt for federal student loans first, only using private loans to fill in the gaps. So before you apply for any private loans, fill out the Free Application for Federal Student Aid (FAFSA). See what you’re offered as far as federal student loans — and other, non-loan aid, especially — goes. And then decide if private loans are a good option for you.

But They Can Be Helpful

Even though private student loans shouldn’t be your first choice, they can still be a decent fill-in in some situations. This is especially the case if you wind up choosing between a Parent PLUS loan and a private loan. Parent PLUS loans have a relatively low interest rate, but they also make the parent responsible for paying the loan. Private loans, on the other hand, can be taken out in a student’s name, so the student has full responsibility for repaying them. (Caveat: If the lender requires a co-signer for the private student loan, and the student borrower defaults, the co-signer will also be held liable for those loans).

You Can–and Should–Shop Around

With federal student loans, you don’t get many choices. The government tells you how much you can take out, sets the terms of different types of loans annually, and you can take it or leave it. They’ll even choose which bank or lender services your federal student loans.

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This is not the case with private student loans. You can shop with as many lenders as you like, and you definitely should shop with at least a few. This way, you can get the best terms and rates for your particular needs.

As you’re shopping around, don’t just look at rates — though they’re important. Look at other terms that could be helpful now or down the road. For instance, if you can make interest-only payments during school, you won’t have to worry about tackling those larger student loan payments right away. And see if a loan offers flexible payment options after college. Some do.

Once you’ve compared loans and chosen the one you want to go with, take out as little money as possible. You don’t want to overdo it. And of course, be sure to read and understand all the loan’s terms before you sign up.

Know Your Payments

With federal student loans, it’s important to understand what you’ll eventually be paying down the road. But this is even more important with private student loans.

Here’s why:

With a federal loan, you may plan on paying, say, $150 monthly once you graduate from college, on a standard repayment plan. Maybe you take out the loan knowing that you should be able to afford that payment on your prospective post-graduation job.

But then you can’t find a job, or end up in a lower-paying job. With a federal loan, you can most likely switch to an income-based repayment plan or an extended plan that will lower your payments.

If you wind up in the same situation with a private loan, you could still be on the hook for that $150 a month — even if you’re unemployed. So be doubly sure you can make the minimum payments on a private student loan, even if life doesn’t go as planned.

Finally, are you looking into a private student loan to cover, say, a $10,000 gap in funding for school? In this case, you might be better off shopping around for a more affordable school.

As you apply for, and obtain, student loans, it’s also good to keep track of your credit standing along the way. Periodically check your credit reports to make sure your loans – and other credit accounts – are being accurately reported, and that there are no mistakes that are hurting your credit. You can also monitor your credit scores as a way to get a quick overview of your credit health – if your score drops unexpectedly, it’s a good idea to check your credit reports for any problems. You can check your credit reports for free once a year, and you can monitor your credit scores for free on Credit.com.