Private student loans are education loans that are offered by private lenders, such as banks or credit unions. These loans usually have higher interest rates, shorter repayment terms, and less flexible repayment options than federal student loans. Plus, borrowers have to pass a credit check for approval.
Those reasons make federal student loans a preferable option in most cases. You can apply for federal loans by submitting the Free Application for Federal Student Aid, or FAFSA, at studentaid.gov. You don’t need to complete the FAFSA to qualify for a private loan, but you should still submit it so you can access free financial aid such as grants, scholarships, and work-study programs.
Keep reading to learn what you need to know before you take out a private student loan. You should know what you’re getting into before you apply.
What is considered a private student loan?
In general, a private student loan is any loan made outside of the federal student aid system to cover a student’s expenses while in school.
But if you file bankruptcy, that definition doesn’t hold up. In bankruptcy court, a debt is defined as a private student loan only if both of these criteria are met:
It was made by a bank, credit union, or online lender like SoFi.
It didn’t exceed the student’s cost of attendance — e.g., educational expenses such as tuition, room and board, textbooks, and other supplies not covered by federal student loans, scholarships, and grants.
This narrow definition leads many private student loan lenders to require “school certification” of a student’s enrollment and cost of attendance before they approve the loan application. The lenders ask for this information to make sure they don’t approve a loan for more than the COA, because if they do, then the loan may not be protected from discharge in bankruptcy.
You can borrow a private student loan if you’re attending an eligible school at least half-time. You will also need to have a steady income and a good credit score — or a cosigner who has both. Most undergraduate students have no credit history or score yet, so they’ll need a cosigner to get approved for a loan.
What credit score is needed for a private student loan? Most lenders look for a FICO score over 650.
There are a handful of financial institutions that don’t consider credit scores, but those subprime loans often carry higher interest rates, lower loan limits, and shorter repayment terms.
You can shop around for the best interest rates, fees, and borrower protections by using an online marketplace like credible.com that lets you compare student loan offers from multiple lenders.
How does a private student loan work?
Private student loans are just like other private loans. You borrow money and then pay it back over time, with interest. The big difference is that private student loans are only for education-related expenses.
To get a private student loan, lenders require you to be creditworthy and be enrolled in a degree-granting program at an eligible school. You’ll also need to provide proof of your cost of attendance.
If you’re approved, the lender will send the money directly to your school to pay the educational expenses not covered by other financial aid.
Payments on the loan start shortly after the money is disbursed. You can make the monthly payments while you’re in school, or you can put the loans in forbearance. When you leave school, it is a good idea to look to refinance at a lower interest rate.
The maximum loan amount you can borrow in private student loans is your college’s cost of attendance, minus any other financial aid you’ve received. You can borrow enough to pay for what grants, scholarships, and federal student loans didn’t cover.
The U.S. Department of Education limits you to $12,500 annually and $57,500 total in Direct Subsidized and Unsubsidized Loans while in undergrad. Graduate students can borrow up to $20,500 annually and $138,500 total.
Federal student loans include:
Direct Loans including subsidized loans, unsubsidized Loans, and PLUS Loans (graduated and parent).
Who are private student loans best for?
You should consider borrowing private student loans if:
You’ve maxed out federal loans and need to cover the gap in college costs.
Your projected income after leaving school will allow you to comfortably make higher monthly payments.
The main difference between private and federal student loans is that the latter are funded by the federal government, while private student loans are made by private financial institutions and schools.
One other difference is that private loans have two types of student loan interest rates: fixed and variable. Fixed-rate loans stay the same throughout the life of the loan. Variable interest rate loans change monthly or quarterly.
Federal loans are preferable to private student loans for two reasons:
You can borrow federal loans even if you don’t have a credit history or income. Banks and online lenders require a good credit score or a co-signer who has one) and enough income to cover your living expenses and loan payments.
Federal loans offer better protections. The Education Department offers its borrowers income-driven repayment plans, loan forgiveness opportunities, and deferments and forbearances during times of hardship (e.g., the Covid-19 pandemic) or permanent disability. Many private lenders don’t offer comparable loan options.
The interest rates for federal loans are typically lower as well. But that hasn’t been true in 2022.
Many lenders are now offering low fixed interest rates to borrowers with excellent credit scores. This is in response to the government’s 0% interest rate during the student loan freeze, which is scheduled to end Sept. 1, 2022.
How to get a lower interest rate on private student loans
If you get stuck with a high interest rate private student loan, you can get a lower one by refinancing. You can refinance with your current lender, but you may find better loan terms with a different company.
To get a better rate on your loans, you’ll need to raise your credit score and increase your income. If you had a co-signer, they might be able to be released from the loan if you have a good credit score. Read more about how to remove a cosigner from a student loan.