What to watch out for before taking out a private student loan
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Why do people take out private student loans?
The cost of a college education has risen sharply, with the annual price for a public college, including room and board, rising to over $18,000 and over $47,000 for a private college.
There are limits to how much students can take out in federal loans — the maximum an undergraduate student can borrow in a year is $12,500 — and so many people are turning to private financing to finish covering their bill.
As a result, the $130 billion private student loan market has grown more than 70% over the past decade, according to the Student Borrower Protection Center.
Americans owe more in private student loans than they do in overdue medical debt or payday loans.
Should students borrow through private lenders?
People should consider taking out a private loan when they’ve reached federal student loan limits and still need education funding, Kantrowitz said.
But, he added, “borrowing from private loans can be a sign of over-indebtedness, so they should do so with caution.”
A rule of thumb is that students should not borrow more from college than they expect to earn as a starting salary.
You can view average annual earnings for different occupations on the US Department of Labor website.
Here’s what else to watch out for…
Federal student loans offer a variety of protections, including remission programs and interest suspension forbearances, that most private student loans do not.
More recently, federal student loan borrowers were able to hit the pause button on their payments for nearly two years during the Covid pandemic, interest-free. This relief has not been extended to private loans.
“There’s also the prospect of broad student loan forgiveness, which may be limited to federal loans,” Kantrowitz said.
“We almost always advise against private lending,” said Betsy Mayotte, president of the Institute of Student Loan Counselors, a nonprofit organization.
“If you can’t make the payments, the lender can take legal action to gain access to wage garnishment, seizure of assets such as bank accounts, and that goes for both the borrower and the co-signer.”
As Mayotte pointed out, many private lenders require students to get a co-signer who is also responsible for the debt.
If payment problems arise, both people are responsible.
“I hear every week from borrowers and co-signers who can’t afford the payments and I just can’t offer them options,” Mayotte said.
Private student loans come with fixed and variable interest rates.
“Generally, borrowers should prefer a fixed rate in a rising rate environment, although variable rates may start lower,” Kantrowitz said. “Variable interest rates have no choice but to rise.”
Either way, rates on loans can be expensive.
“I’ve heard of interest rates as high as 18% on private student loans,” Kantrowitz said.