How Does Private Student Loans Work

How Do Private Student Loans Work?

Private student loans are a financial aid option available to students who need assistance paying for college, but don’t qualify for federal loans or grants. They’re often called “alternative student loans.”

The biggest difference between private and federal student loans is that private loans are not guaranteed by the government. That means that if you default on your payments, your lender may take action to collect from you—including garnishing your wages or taking money from your bank account. If a federal loan is in default, however, there’s no action taken by the government—it’s just the lender who does its best to recover what it can from you.

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Private student loan volume grows when federal student loan limits remain stagnant.

Private student loan volume grew much more rapidly than federal student loan volume through mid-2008, in part because aggregate loan limits on the Stafford loan remained unchanged from 1992 to 2008. (The introduction of the Grad PLUS loan on July 1, 2006 and the increases in the annual but not aggregate limits had only a modest impact on the growth of private student loan volume. The subprime mortgage credit crisis of 2007-2010, however, limited lender access to the capital needed to make new loans, reining in growth of the private student loan marketplace.) The annual increase in private student loan volume was about 25% to 35% per year, compared with 8% per year for federal loan volume.

Then the Ensuring Continued Access to Student Loans Act of 2008 increased the annual and aggregate loan limits on the federal Stafford loan starting July 1, 2008. This shifted significant loan volume from private student loan programs to federal. Private student loan volume dropped in half in 2008-09, according to the College Board’s Trends in Student Aid 2009.

Private student loan volume is expected to return to the 25% annual growth rate unless there is another increase in federal loan limits or an expansion of the availability of federal student loans. For example, the proposal for expanding Perkins loan funding from $1 billion a year to $8.5 billion a year will cause a significant decline in private student loan volume. But so long as federal loan limits do not increase every year, private student loan volume will continue to grow at double-digit rates.

If current trends continue, annual private education loan volume will surpass federal student loan volume by around 2030. Accordingly, it is important that students have tools they can use to compare different private student loans.

BEST PRIVATE STUDENT LOANS

As a general rule, students should only consider obtaining a private education loan if they have maxed out the Federal Stafford Loan. They should also file the Free Application for Federal Student Aid (FAFSA), which may qualify them for grants, work-study and other forms of student aid. Undergraduate students should also compare costs with the Federal PLUS Loan, as the PLUS loan is usually much less expensive and has better repayment terms. Grad students can find the best graduate loan options on Finaid as well.

The fees charged by some lenders can significantly increase the cost of the loan. A loan with a relatively low interest rate but high fees can ultimately cost more than a loan with a somewhat higher interest rate and no fees. (The lenders that do not charge fees often roll the difference into the interest rate.) A good rule of thumb is that 3% to 4% in fees is about the same as a 1% higher interest rate.

Be wary of comparing loans with different repayment terms according to APR, as a longer loan term reduces the APR despite increasing the total amount of interest paid. Finaid’s Loan Comparison Calculator may be used to generate an apples-to-apples comparison of different loan programs.

The best private student loans will have interest rates of LIBOR + 2.0% or PRIME – 0.50% with no fees. Such loans will be competitive with the Federal PLUS Loan. Unfortunately, these rates often will be available only to borrowers with great credit who also have a creditworthy cosigner. It is unclear how many borrowers qualify for the best rates, although the top credit tier typically encompasses about 20% of borrowers.

Generally, borrowers should prefer loans that are pegged to the LIBOR index over loans that are pegged to the Prime Lending Rate, all else being equal, as the spread between the Prime Lending Rate and LIBOR has been increasing over time. Over the long term a loan with interest rates based on LIBOR will be less expensive than a loan based on the Prime Lending Rate. About half of lenders peg their private student loans to the LIBOR index and about 2/5 to the Prime lending rate.

Some lenders use the LIBOR rate because it reflects their cost of capital. Other lenders use the Prime Lending Rate because PRIME + 0.0% sounds better to consumers than LIBOR + 2.80% even when the rates are the same.

It is not uncommon for lenders to advertise a lower rate for the in-school and grace period, with a higher rate in effect when the loan enters repayment.

Federal student loans are not available for expenses incurred by law, medical and dental students after they graduate, such as expenses associated with study for the bar or finding a residency. There are two types of private student loans for these expenses:

A Bar Study Loan helps finance bar exam costs such as bar review course fees, bar exam fees, as well as living expenses while you are studying for the bar.
A Residency and Relocation Loan helps medical and dental students with the expenses associated with finding a residency, including interview travel expenses and relocation costs, as well as board exam expenses.

federal student loans

Studentaid.gov contains information on all federal student loans. It’s the easiest way to determine if your loans are federal and get any loan information you may need. If you don’t see your loan information on studentaid.gov, you don’t have a federal student loan.

You access the site with your FSA ID to see your loan amount, status, servicer, outstanding balance and disbursement details. You can also apply for loan consolidation or sign up for an income-driven repayment plan there.

There are two ways to determine whether a loan is federally or privately held:

1. Check the top of your federal loan promissory notes, applications, and billing statements, as these state the name of the federal loan program at the top of the document. Federal loan programs include the William D. Ford Federal Direct Loan Program, the Federal Perkins Loan Program, and the Federal Family Education Loan (FFEL) Program.

2. Log in to StudentAid.gov using your FSA ID (account username and password) and select “My Aid” under your name. My Aid displays information on all federal loan and grant amounts, outstanding balances, loan statuses, and disbursements.

Contact your loan servicer
Federal loans are managed by one of nine student loan servicers. You can contact 1-800-4-FED-AID, the federal student aid helpline, to determine if your loan is managed by any of them. If so, the helpline can connect you to your servicer for more information about your loan.

Most borrowers with private loans won’t be able to reach their servicer by calling the student aid helpline. Some federal loan servicers also issue private loans, however, so make sure to verify which you have when you call.

Review your billing statement
For federal student loans, the top of a student loan bill will have the name of your student loan servicer and the name of your federal student loan program.

For private student loan bills, you’ll see the name of your private lender on the bill instead.

How to check private student loans
Unlike with federal student loans, there is no centralized database with all private student loan information.

And private student loans don’t qualify for the current interest-free forbearance. They also aren’t being considered for student loan forgiveness. If you want to lower your payment or repay your private loan faster, consider student loan refinance.

You’ll know your loans are through a private lender if you check studentaid.gov or use the other methods mentioned above and can’t verify your loans are federal.

If you are not in touch with your lender, one good way to track down your private student loan debt is through your credit report. Pulling a free credit report won’t affect your credit score and will give you a list of your debts. Your credit report will show your outstanding balance from the date the information was collected and will tell you which lender owns the debt. Contact the lender listed to get more information on your private student loan.

You can also check with your school. Because student loans are disbursed directly to the college, your school’s financial aid office may have a record of where your loan money came from.

who is eligible for private student loans

If you don’t qualify for federal loans or if they are not enough to help you cover all your expenses, you might choose to apply for private student loans through banks or other financial institutions. You can use our comparison tool to see if you are eligibe for a loan. Because students typically can’t defer them the way they can federal loans, private loans should only be used as a last resort. However, in some cases it is necessary. Your personal credit will be checked to determine the interest rates of your loans.

Before Applying
Before applying for a private student loan, you should know exactly how much you need to borrow. To do this, review the financial aid award letter sent to you by your school. Next, find a loan that meets your needs. You can use our Loan Comparison Tool to help you find a loan that suits you.

Next, you will need to collect all the information you will need for the application. This includes:

School information, including school name, major, grade, and school term for which you need the loan
Social Security number (as an international student, this may not be applicable)
Telephone numbers
Current addresses, both for your home and your school
Personal reference information and phone number
Gross income information
Residence information, including whether you own or rent, and the monthly housing payment
Requested loan amount
What if I’m applying for an international student loan before being accepted?
Although with some loans and financial aid it is possible for an international student to apply before being formally accepted by a school, it is not possible to receive the funds. Loan funds can only be disbersed after the amount is confirmed by the financial aid office at your school.

Sign the Documents
You will need to sign the consumer credit agreement, and the self-certification form to show that you’ve verified the amount you need to borrow. Additionally, your school will verify that you have enrolled and that your requested loan amount does not exceed the cost of attendance (maximum loan amount). The school certification may impact the amount you requested.

Next, you will need to sign your Promissory Note, which states that you will repay the loan in full, and complete the Self-Certification Form.

Loan Disbursement
Finally, you must accept the loan terms.

After that your loan funds will be disbursed (sent) to your school to cover tuition and any other charges directly paid to the school. You will receive any remaining loan proceeds from your school once they have been applied to your student account. You may use these remaining funds to cover living expenses and any other potential personal expenses related to the cost of education.

Repaying Your Loan
With some loans, you won’t have to start paying them back for a certain period of time (period of forbearance).

For example, the government will take care of the interest on Federal Stafford Subsidized loans while you are in school. After school, students will generally have several months before they must begin repaying federal loans.

With private loans, however, the period of repayment often begins right away, even while the student is in school. An increasing number of lenders are offering a short grace period before repayment begins.

You should carefully consider all borrower requirements before acceptong a loan, including repayment period, repayment term, repayment options, monthly payments, deadlines and range of rates.

While applying for student loans may seem like a complicated process, it’s really not and very often it is necessary for students who want to attend school outside their home country.