While federal loans should always be your first borrowing choice, they may not cover your full tuition – never mind lab fees, books, and room and board. That's where private loans come in to fill in the gap. However, private loans are often harder to get and more difficult to pay off.
Like car loans, mortgages and credit cards, private student loans are granted based on a general risk assessment of one's ability to pay back the loan. Because most private loans have variable interest rates, monthly payments can vary throughout your repayment period, making it difficult to gauge exactly what your payments are going to be upon graduation. This uncertainty poses problems when it comes to budgeting for the future.
In this tutorial, you will learn when it makes financial sense to borrow money for your education via a private loan, as well as how to apply, qualify and be as prepared as possible for your eventual repayment responsibilities. But first we'll examine the differences between private loans and federal loans.
Private vs. Federal Loans
|Federal Loans||Private Loans|
|Fixed interest rates||In general, variable interest rates|
|Federal government guaranteed loans for banks, so credit checks aren't required||Credit check required|
|Universal rules on repayment in case of hardship – no matter who the lender is||Repayment terms depend on individual lender|
|Exempt from bankruptcy protection||Exempt from bankruptcy protection|
|Extra fees only charged in case of default||Rates may be raised if you miss a payment|
|Missed payments are noted on credit reports and can decrease your credit score||Missed payments are noted on credit reports and can decrease your credit score|
|If default occurs, there is a uniform route to returning your loan to good standing.||If default occurs, it is up to the lender to determine penalties and changes to the interest rate|
Federal Loans – Your Best Option
As you can see from the above table, federal loans have many benefits that are not afforded to private loan borrowers. Therefore, it is important to exhaust your federal borrowing limit before considering private loans to fund your education.
When to Apply for Private Loans
Consider private loans only when you are confident that you will follow through with a career choice and make enough to pay back your student loans. Also, make certain you have budgeted for both what your payment will be at the current interest rate, as well as the maximum your payment could be according to your specific contract terms.
Qualifying for Private Loans
Qualifying for a private student loan is similar to qualifying for credit card, mortgage, car loan or personal bank loan. If you don't have an established credit history and a high credit score, you will need a cosigner who does. The loans are offered by private banks, and you can find private lenders via internet searches, your own bank's loan office or through your prospective university's financial aid office. (For tips on getting a loan without a cosigner, see Getting A Loan Without Your Parents and How To Establish A Credit History.)
Private Loan Contract Terms
It is extremely important to study the contract terms of your private loan because the terms will vary according to the lender (unlike federal loans, in which the terms are universal). Before signing anything, ask potential lenders for a sample contract to review and have your prospective university's financial aid counselor review the contract with you. Financial aid counselors know what to look for and can help you decipher whether you are getting a good deal and an interest rate you can handle for the long term. What to look for in your contract:
- Your current interest rate terms, the financial index to which your interest rates is tied to plus the additional margin you pay. You need to see what your interest rate is, why and how it can be raised, and how high it could go. While how high your interest can go depends on usury laws for consumer lending, you can get a sense of how high your rate could go by checking the historic rates for LIBOR and PRIME, the two main financial indexes, on the Federal Reserve website.
- What, if any, provisions there are for temporary financial hardship.
Private Loans and Financial Hardship
If you have private loans, how you deal with financial hardship is the same as you would for a mortgage or other non-student loan. Call your lender at the first sign you might have trouble making payments and ask about temporary reprieves from payments or request to temporarily make smaller payments. Also, ask about extending and lowering your payments via a private loan consolidation. The earlier you act, the more likely your lender will work with you. Finally, check your contract to see if there is any mention of options for dealing with financial hardship.
If your private loan lender will not budge on helping you through a difficult financial time, look for other loan vehicles such as credit cards with low balance transfer rates or try to rearrange your budget to make your private loans a priority. For instance, if you have federal loans, request a forbearance or deferment; these loans have much more forgiving terms for financial hardship. (For more on this options, see Student Loan Deferment: Live to Pay Another Day.)
Some Final Considerations
Private loans can play as pivotal a role in your education as federal loans. If you've exhausted your annual federal loan borrowing limits, you can take out a private loan to make up with the difference. However, if you can't conceivably repay the loans in the future, you need to search harder for scholarships or other ways to pay for your education – or choose a more affordable university.
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