If you’re a student, you’re likely to receive mail from private student lenders offering to cover “up to 100 percent” of your tuition costs.
Sounds good right? But students and their families should be cautious about such offers, say financial aid experts. Private loans — those from banks and lenders other than the federal government — offer less borrower protection than federal loans and tend to be more expensive. And unlike federal student loans, they can have interest rates that vary over the life of the loan. That could mean higher monthly payments as interest rates are likely to rise.
Federal loan rates, hit by rising Treasury yields, are expected to rise more than a percentage point for the next academic year, but they will still be a better deal than personal loans for most borrowers. That’s because less than 10 percent of personal borrowers — those with excellent credit ratings — are typically eligible for the lowest advertised rates on personal loans, said Mark Kantrowitz, a financial aid expert. Most borrowers receive higher, sometimes double-digit interest rates.
In addition, state student loans offer repayment schedules tied to a borrower’s income and options to pause payments if the borrower’s finances run into trouble. Borrowers may be able to forgive their debt if they work in the public sector — particularly if changes to the program work as planned. Private lenders may offer flexible payment plans or forbearance options, but don’t have to, student advocates say.
“Buyer beware,” said Michele Streeter, associate director of policy and advocacy at the Institute for College Access and Success.
The general payment pause for federal student loans, which is currently extended to August 31, does not apply to private loans. And a future student loan waiver by the federal government should not apply to private loans either.
“Government student loans are almost always preferable to private student loans,” said Abby Shafroth, an attorney at the National Consumer Law Center who focuses on student loans.
It is usually best for students to cover as much as possible from non-repayable grants and grants and from pre-borrowing savings and income. But many students still cannot afford college without credit.
Students who need credit should first opt for federal loans, although these credits have limits on how much can be borrowed. In the first year, the dependent student limit is $5,500, and the limit increases to $7,500 in the third and fourth years. The total cap is $31,000 – if the degree is longer than four years. (Limits are higher for independent and graduate students.)
But because of the high cost of college, students may be turning to private loans because they need more than they can get from the federal government. The average published price A year at a public, four-year college (including state tuition, fees, and room and board) was nearly $23,000 for the 2021-22 school year, according to the College Board. The average was nearly $52,000 at four-year, private, not-for-profit colleges.
Student Loans: Important Things to Know
Student Loans: Important Things to Know
New rules. The Department of Education is preparing a new set of rules for federal student loans aimed at expanding access to various assistance programs. The measures also include restrictions on the capitalization of interest – whereby unpaid interest is added to the borrower’s principal balance, compounding the total amount owed.
To fill the gap, families can turn to alternatives such as Parent Plus loans — federal loans with higher interest rates than direct student loans that are available to parents after a cursory credit check — or personal loans. Some data suggests that many students taking out private loans have not exhausted their federal loans, suggesting they may not be aware of differences between loan types, Ms Streeter said.
“We encourage students to borrow up to the maximum federal eligibility before turning to private loans,” she said. Private lenders can ask a borrower’s college to certify that a student has exhausted federal loans, she said, but that’s not a requirement.
Mr. Kantrowitz said the need to borrow parental or private student loans could be a red flag, prompting families to reconsider their approach to their child’s education. It “can be a sign that the family is borrowing too much to pay for college,” he said.
Students choosing private loans should shop around to compare interest rates and terms, Mr. Kantrowitz said.
Unlike government student loans, private student loans require a credit check, and only applicants with top ratings receive the best rates.
Because many students do not have a credit history, private loans often require an applicant to have a co-signer, usually a parent, who is responsible for making payments if the borrower defaults. Getting fired as a co-signer can be difficult, Mr Kantrowitz said, leaving parents potentially on the hook for a long time.
Factors like customer service should also be considered, Mr. Kantrowitz said. Is there a hotline if you need to reach someone at the weekend? Can you update your address or contact details online?
Private lenders include Sallie Mae, which made loans to more than 397,000 families in 2021 (“more than any other private lender,” according to its regulatory filings), and Citizens Bank, as well as online lenders like College Ave and SoFi.
At least a dozen states also offer student loans through special programs, usually for state residents attending a state college. Borrowers should not assume that interest rates and terms from government agencies are better than those from private, for-profit lenders, Ms Streeter said. Be sure to check the details.
Here are some questions and answers about student loans:
What is a reasonable loan amount for college?
Mr. Kantrowitz recommends that your total student debt should be less than your expected first-year salary. If your debt is less than your annual income, you should be able to pay off your student loans in 10 years or less, he said. If you expect to make $55,000 — the average starting salary for a four-year college grad in 2021 — your loan totals should fall below that amount. A similar rule applies to parents, he said. They should not borrow more than their annual income for all their children combined.
What are the current student loan interest rates?
Federal student loan interest rates are set annually and apply to all new loans made during a particular academic year. The interest rate is fixed for the term of the loan. Student direct loan rates are currently 3.73 percent. However, they are expected to rise to 4.99 percent for loans originating from July 1 through June 2023. I haven’t officially announced the new interest rates, but Mr. Kantrowitz and others are forecasting them based on the auction for 10-year government bonds, which took place on Wednesday.)
While that sounds like a big leap, the impact on a borrower’s monthly payment is only about $3 more for a student borrowing the maximum of $5,500 in the first year and paying the debt over a standard 10-year term repays, according to the Bankrate.com credit estimator.
Personal loan interest rates vary by lender. Many are currently advertising fixed interest rates from 3.2 percent to over 14 percent and variable-rate loans from around 1 percent. However, interest rates on personal loans, both fixed and floating, are expected to rise as the Federal Reserve continues to raise its benchmark interest rate, said Greg McBride, chief financial analyst at Bankrate. “Private student loans are also on the rise.”
But think twice before taking out an adjustable-rate loan now, Mr. Kantrowitz said. For these loans, the lowest interest rates “just have to go up.”
Are there limits to the amount of personal loan I can borrow?
Some lenders set a minimum loan amount — say $1,000 — and cap the loans to the college’s annual tuition costs.