Choosing a Private Student Loan: What to Look For
In general, taking out a private student loan should be a last resort. First, be sure you’re exhausting all your options for federal student aid—and get apply for as many grants and scholarships as you can.
To decide if you need a private student loan, add up the amount of tuition you’ll be able to pay out of your own or your parents’ expected contributions, federal loans, grants and scholarships. If there is a large difference between the tuition costs and the funds you’ve been able to come up with so far, you will likely need to take out a private student loan to cover the difference. Here are a few guidelines for comparing private student loans—and getting the best deal.
Talk to credit unions as well as banks
Credit unions serve the same roles as banks and offer the same services, but they’re nonprofit while banks have shareholders. As such, the terms on a student loan from a credit union might be more beneficial to you than a loan from a for-profit bank. Be sure to look at credit union loans as well as loans from banks.
Choosing student loan options is never easy. Avoid taking out a private student loan if you can pay for your college tuition by any other means.
“APR” stands for “Annual Percentage Rate.” It’s the total cost of the loan—including all fees and interest charged on top of the principal, or the amount you’re actually borrowing. It’s generally expressed as a percentage of the principal.
Interest rates on private student loans are usually variable. The average student loan interest rate is around 12%, although your lender might offer significantly lower interest to get you into the deal.
Fees charged by some lenders can increase the cost of the loan significantly. Bear in mind that a low-interest loan with high fees can often cost more than a loan with higher interest and zero in fees. Factor in the equivalent of a 1% interest rate increase for every 3% to 4% in fees.
Compare repayment periods
Repayment conditions may vary between different lenders and loans. Most private lenders will give you a grace period exempting you from making monthly payments while you’re in school. This period usually ends about six months after graduation, however. But interest will still accumulate during your grace period and the bank will add it to the principal. Find out how long your grace period will be, how much interest will accrue over that period of time, and whether that number will be factored into the total principal—this will affect how much interest you pay.
How long is the term?
The “term” is the length of time you will be expected to take to repay the loan. Find out whether you will be able to pay off the loan in full before the term ends without incurring a financial penalty—often called a “prepayment penalty.” Ideally, you should be able to pay off the loan in full at any time without taking a financial hit.
What would the monthly payment be?
This can be difficult to calculate, because most private student loans have variable rates. However, it’s important to try to get a ballpark figure. Many financial experts recommend that your student loan payments be less than 8% of your total income before taxes, and that you make payments at least on your accumulating interest while you are in school to reduce the total amount owed later.
What are the terms on the variable rate?
Your monthly interest rate will likely change on a monthly basis. There is currently no legal limit on how high this rate can go, although some loans come with a cap. Most lenders will lure students in with a low introductory rate or a low rate during the grace period.
Choosing student loan options is never easy. Avoid taking out a private student loan if you can pay for your college tuition by any other means—they typically have the worst interest rates and repayment terms. If you’ve exhausted all other options, look for a student loan with a cap on its variable interest rate, low APR, a manageable monthly payment, and no penalties for paying the loan off early. If you can find a private loan with decent payment terms, it will be much less of a burden after you graduate.
More About Understanding Student Loans
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- Questions You Should Ask Before Applying for Student Loan Forbearance
- The Bank on Students Act: What It Is, and How It Could Help Student Borrowers
- How the Death of a Co-Signer Can Affect Your Student Loan
- Peer-to-Peer Student Loans: What They Are, and How They Can Help You Pay for College
- If You're Unable to Work Because of a Disability: What Happens to Your Student Loan?
- New Rules for Debt Collectors: How They Could Affect Your Student Loan
- Having Trouble Repaying Loans? The Department of Education May Be in Touch