By: Emily Ferreira, Managing EditorA private student loan is a financing option for college or other types of “higher education” than can supplement or completely replace a federally guaranteed student loan such as a Stafford student loan, Perkins student loan or a PLUS loan. A private student loan is an unsecured student loan with various options for repayment. A private student loan may offer forbearance and deferral options as well.
By contrast to a federal student loan, a private student loan has interest rates that are set by the financial institution that underwrites the private student loan. These interest rates are usually based on the perceived risk that the borrower may be delinquent or in default of payments on the private student loan. The underwriting decision is further complicated by the fact that students usually don’t have a credit history that could otherwise indicate they are trustworthy borrowers. This results in interest rates that may differ greatly between private student loan lending institutions. Some lenders may employ innovative underwriting approaches when drawing up the private student loan contract so they are able to offer students lower rates. A private student loan is also subject to special treatment if personal bankruptcy becomes an issue. In this case, students may not incur a total debt that exceeds their cost of attendance. This would include any scholarships, student financial aid, fellowships, federal loans and private loans.
As mentioned previously, several varieties of student loans exist within the Federal and Private sectors. Federally sponsored student financial aid loans can include Perkins Loans, Stafford Loans and PLUS Loans. The Perkins loan is offered to students demonstrating financial need for student financial aid and offers a fixed 5% interest rate and nine-month grace period, as opposed to the more common six-month grace period. Additionally, the Perkins loan is a subsidized student loan, which means that interest does not begin to accrue until the borrower begins to repay the loan. The Stafford loan can also be federally sponsored, but differs significantly from the Perkins college student loan as it can also be obtained from a private lender and may be either subsidized or unsubsidized. Stafford student loans have a dual structure interest rate that sets them apart. While the student is in school and during their grace period, the interest rates are lower. However, once they begin repayment, interest rates will increase. PLUS parent student loans differ from both of these varieties of student loans. A PLUS loan is made to the parent directly, though recently these loans have also been made available to graduate students as well. These student loan amounts are often much higher, however, the parent is responsible for beginning repayment immediately. Additionally, the interest rate on these college student loans was raised to 8.5% as of July 1, 2006. By contrast, private student loans are generally obtained from a separate student loan company and their interest rates are often higher than government loan rates and allow for larger sums to be borrowed. The interest rates are usually based on one or multiple financial factors such as the current Prime rate, The Wall Street Journal, the London Interbank Offered Rate or the British Bankers Association. It should also be noted that money paid toward interest on any college student loan is tax deductible.
There are several institutions that offer a private student loan as an option for students in need. There are some larger banks such as Citibank, Wachovia and Bank of America that provide student financial aid in the form of a private student loan. In addition, there are specialized private student loan companies such as Sallie Mae that provide these loans. Student financial aid offices in universities generally have a preferred vendor list that students may look at prior to making their decision. However, students are free to get a private student loan from wherever they can find the best terms.
There are several deciding factors when considering where to get a private student loan. Interest rates are probably the biggest factor as they determine how much money will need to be repaid over the life of the private student loan. Some lenders may begin to accrue interest at one rate while the student is in school and then change to a different rate following graduation. The various options for repayment of the loan also weigh heavily. Some lenders offer a private student loan that is payable immediately but there are still others that are considered “interest-only” while the student is enrolled and, finally, there are no-payment loans that don’t begin repayment until graduation. Other deciding factors are origination fees that lenders traditionally charge for originating a loan that is added to the principal of the private student loan. Incentives also play a big part. Some lenders offer improved or tougher terms of repayment based upon the student’s payment record.
