If you’re a college student, you probably get mail from private student lenders offering to cover “up to 100 percent” of your educational costs.
Sounds good, right? But students and their families should tread cautiously with such offers, financial aid experts say. Private loans — those from banks and lenders other than the federal government — carry fewer borrower protections 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 rates probably rise.
The rates on federal loans, which are affected by rising yields on government bonds, are expected to increase by more than a percentage point for the next academic year, but they will still be a better deal than private loans for most borrowers. That’s because less than 10 percent of private borrowers — those with excellent credit — typically qualify for the lowest advertised rates on private loans, said Mark Kantrowitz, a financial-aid expert. Most borrowers get higher, sometimes double-digit, interest rates.
Plus, federal student loans offer repayment plans tied to a borrower’s income and options to pause payments if the borrower’s finances hit a rough patch. Borrowers may be able to have their debt forgiven if they work in public service jobs — especially if changes to the program work as planned. Private lenders may offer flexible payment plans or forbearance options, but they’re not required to do so, student advocates say.
“Buyer beware,” said Michele Streeter, associate director of policy and advocacy with the Institute for College Access and Success.
The current general payment pause on federal student loans, which has been extended to Aug. 31, doesn’t apply to private loans. And any future student loan forgiveness granted by the federal government is also unlikely to apply to private loans.
“Federal student loans are almost always preferable to private student loans,” said Abby Shafroth, a staff attorney at the National Consumer Law Center who focuses on student loans.
It’s usually best for students to cover as much of the cost of college as they can from grants and scholarships, which don’t need to be repaid, and from savings and income before borrowing. But many students still cannot afford college without loans.
Students who need loans should first opt for federal loans, though those loans have limits on how much can be borrowed. In the first year, the limit for dependent students is $5,500, and the limit rises to $7,500 by the third and fourth years. The total cap is $31,000 — in case it takes longer than four years to graduate. (Limits are higher for independent and graduate students.)
But because of the high cost of college, students may turn to private loans because they need more than they can get from the federal government. The average published price of one year at a public, four-year college (including in-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 nonprofit colleges.
To make up the gap, families may turn to alternatives like Parent Plus loans — federal loans with higher interest rates than direct student loans that are available to parents after a cursory credit check — or private loans. Some data suggest that many students who take out private loans haven’t maxed out their federal loans, suggesting they may not be aware of the differences between the 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 may ask a borrower’s college to certify that a student has maxed out federal loans, she said, but it’s not a requirement.
Mr. Kantrowitz said that a need to borrow parent or private student loans may be a red flag alerting families to rethink their approach to their child’s education. It “may be a sign that the family is borrowing too much to pay for college,” he said.
Students who do choose private loans should shop around to compare rates and terms, Mr. Kantrowitz said.
Unlike with federal student loans, private student lenders require a credit check, and only applicants with top-notch scores get the best rates.
Because many students haven’t established credit histories, private loans often require an applicant to have a co-signer, usually a parent, who is responsible for payments if the borrower defaults. Getting released as a co-signer can be difficult, Mr. Kantrowitz said, so parents may be on the hook for a long time.
Factors like customer service should also be considered, Mr. Kantrowitz said. Is there a help line if you need to reach someone on the weekend? Can you update your address or contact information online?
Student Loans: Key Things to Know
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Debt reduction. President Biden said that he is considering wiping out some student loan debt and will make a final decision “in the coming weeks.” The comments were the clearest signal yet that he may make good on one of his campaign promises.
New sources of aid. The Education Department will use one-time waivers and adjustments to retroactively credit millions of borrowers with additional payments toward loan forgiveness. The move will help people seeking to have their loans eliminated under the Public Service Loan Forgiveness program and through the use of income-driven repayment plans.
Payments delayed again. President Biden pushed the restart date for federal student loan payments to Sept. 1, extending a pause put in place at the start of the pandemic. Millions of borrowers who have defaulted on their federal student loans will also get a fresh start and have their loans restored to good standing.
The cost of private loans. As the Fed changes its benchmark rate, private student loan borrowers should expect to pay more, as both fixed and variable rate loans are linked to benchmarks that track the federal funds rate.
Private lenders include Sallie Mae, which originated loans to more than 397,000 families in 2021 (“more than any other private loan lender,” according to its regulatory filings), and Citizens Bank, as well as online lenders like College Ave and SoFi.
At least a dozen states offer student loans through special programs as well, typically to state residents attending college in state. Borrowers shouldn’t assume that rates and terms from state 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 amount to borrow 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 repay your student loans in 10 years or less, he said. If you anticipate earning $55,000 — the average starting salary for a four-year college graduate in 2021 — the total of your loans should fall below that amount. A similar rule applies to parents, he said. They should borrow no more, for all of their children combined, than their annual income.
What are current interest rates on student loans?
Interest rates on federal student loans are set annually and apply to all new loans made during a given academic year. The rate is fixed for the life of the loan. Rates for undergraduate direct loans are currently 3.73 percent. But they are expected to jump to 4.99 percent for loans made starting July 1 through June 2023. (Rates on federal loans are set each spring and are tied to the 10-year Treasury note, using a formula set by law. The Education Department hasn’t officially announced the new rates, but Mr. Kantrowitz and others are projecting them based on the 10-year Treasury bond auction that took place on Wednesday.)
While that sounds like a big jump, the effect on a borrower’s monthly payment is only about $3 more for a student borrowing the first-year maximum of $5,500 and repaying the debt over a standard 10-year term, according to Bankrate.com’s loan estimator.
Rates on private loans vary by lender. Many are currently advertising fixed rates ranging from 3.2 percent to more than 14 percent, and variable rate loans starting around 1 percent. But rates on both fixed and variable rate private loans are expected to rise as the Federal Reserve continues raising its benchmark interest rate, said Greg McBride, chief financial analyst at Bankrate. “Private student loans are on the way up as well.”
But think twice before taking out a variable rate loan now, Mr. Kantrowitz said. For those loans, the lowest interest rates “have nowhere to go but up.”
Are there limits on the private loan amount I can borrow?
Some lenders set a minimum loan amount — say, $1,000 — and cap loans at the college’s annual cost of attendance.