Everywhere you look for student loan information, you’ll see a common piece of advice: Exhaust your federal options before considering private lenders.
After all, about 90 percent of student loans are originated by the federal government, according to The College Board.
But what if following conventional wisdom costs you more money? For some borrowers, it’s best to prioritize private loans over federal. Here’s what to consider.
What you give up with private loans
During the 2011-2012 academic year, 11 percent of private loan borrowers applied for federal aid but didn’t take out a Direct Loan, found a Student Loan Hero study. Twenty-eight percent took Direct Loans but didn’t max them out.
Chances are some of those private student loan borrowers would’ve been better off taking only federal aid. For others, though, it might’ve made more sense to take out private loans.
That would be the case if the borrowers didn’t qualify for a Direct Subsidized Loan, on which the government pays in-school interest.
Borrowers might also have found a lower interest rate from private lenders, which can offer variable interest rates in addition to fixed. Variable rates, unlike fixed rates, fluctuate depending on indexes like LIBOR.
That would explain why some of these borrowers gave up significant loan protections — the real differentiating factors between federal and private student loans.
Private lenders might not offer:
- Deferment on loan payments while you’re in school
- A grace period after you graduate
- Economic hardship protections
- Flexible repayment options
- Loan forgiveness or cancellation programs
You’re much likelier to find a private lender that offers in-school deferment than one that offers a path to any sort of loan forgiveness. If you can’t imagine a loan with any of these protections, ask a private lender before moving forward.
3 types of borrowers who might benefit from private loans
In many cases, the choice between federal and private student loans is black and white. An incoming freshman coming from a low-income family should chase federally subsidized loans and put on their blinders when private lenders come calling.
For certain other borrowers, though, there’s more of a choice. Here are three types of borrowers who could benefit from going private.
1. An undergraduate with a creditworthy co-signer
Unlike federal loans, private loans are credit-based. That is to say that the interest rate you can score from a private lender is highly dependent on your credit history. The longer, more impressive history you have, the lower rate you can secure.
The problem is that most teens and 20-somethings who attend a four-year school have limited credit histories. If you fall into this category, you might not have a credit score at all.
This is where co-signers come into play. A good co-signer — one with a steady income and a credit score that attracts private lenders — could net you a lower interest rate. They do this by supporting your application with their more-attractive credit history.
In another case, say you’re considering asking your credit-worthy mom or dad to take out a Direct PLUS Loan (7.00%). Even if you’re wary of variable rates, a lender like Citizens Bank could save you money by having a parent co-sign a fixed-rate loan starting at 5.09%.
Potential red flag: Although many federal loans are not without loan fees, private lenders might try to sneak in a hefty loan origination fee. Make sure you put a low rate in the context of other fees before deciding on a federal or private loan.
2. A professional who is returning to school
Not all of us go straight from high school to college. You might make a little money before heading back to campus.
If you fall into this bucket, you might not need a co-signer to receive a low-rate offer from a private lender. As long as you can fulfill the same criteria — stable income and a strong credit score — you might be in for some serious savings.
If you’re an undergraduate, you might find yourself deciding between a Direct Loan at 4.45% or, say, a CommonBond private loan with variable rates ranging as low as 3.95% – 9.83% for the same, standard 10-year repayment term.
Check the fine print before taking the plunge, though. Your private lender might not want you quitting your job before returning to school, for example, and your loan agreement might depend on whether you’re enrolled part or full time.
Potential red flag: Making a private-over-federal choice like this one assumes you’re comfortable going with a variable interest rate over a fixed one. Weigh the pros and cons of the debate to make sure the risk of fluctuating rates is worth the reward of potential savings.
3. A graduate student aiming for a high-salaried career
Like professionals returning to school, graduate students are likely independent borrowers who don’t need a co-signer.
If you count yourself in this group, know that taking out private loans isn’t a rarity — it might be a necessity if you max out your federal allowance. Twenty percent of 2012 graduate loans were from private lenders, according to our data.
Once you’ve used up your Direct Subsidized Loan allotment, currently at 6.00%, you’re left with Direct PLUS Loans, which carry a 7.00% rate.
Consider that a private lender like Sallie Mae starts its APRs for graduate and professional students at 6.00%. Further, you’ll find that its graduate student loan option, unlike a PLUS Loan, has no origination fee.
Potential red flag: You usually give up something to get something. Beyond protections, selecting a private loan over a federal loan might not be wise if you prefer a 20- or 25-year repayment term.
Even top-rated private lenders only offer up to 15-year terms. But if you’re headed toward a financially rewarding career, you might prefer a shorter loan term anyway.
Compare federal and private rates
If you fit the profile of someone who might benefit from taking out a private loan before a federal loan, your work isn’t done. You need to go rate shopping.
Just be aware that loan inquiries can affect your credit score. We recommend filing applications with private lenders within a 14-day window.
Although some private lenders might beat the federal government’s rates, there’s more to consider than APRs. Consider term lengths, fees, protections, and repayment options to start.
The point is to collect as much information as you can, even if it eventually directs you to a federal student loan. You don’t want to miss out just because you followed the crowd.
Need a student loan?Here are our top student loan lenders of 2019!
|1 Important Disclosures for Ascent.
Before taking out private student loans, you should explore and compare all financial aid alternatives, including grants, scholarships, and federal student loans and consider your future monthly payments and income. Applying with a cosigner may improve your chance of getting approved and could help you qualify for a lower interest rate. Ascent Student Loans may be funded by Richland State Bank (RSB). Ascent Student Loan products are subject to credit qualification, completion of a loan application, verification of application information and certification of loan amount by a participating school. Loan products may not be available in certain jurisdictions, and certain restrictions, limitations; and terms and conditions may apply. Ascent is a federally registered trademark of Turnstile Capital Management (TCM) and may be used by RSB under limited license. Richland State Bank is a federally registered service mark of Richland State Bank.
* Application times vary depending on the applicants ability to supply the necessary information for submission.
2 Important Disclosures for CollegeAve.
College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply.
Information advertised valid as of 2/1/2019. Variable interest rates may increase after consummation.
3 Important Disclosures for Discover.
* The Sallie Mae partner referenced is not the creditor for these loans and is compensated by Sallie Mae for the referral of Smart Option Student Loan customers.
4 = Sallie Mae Disclaimer: Click here for important information. Terms, conditions and limitations apply.
5 Important Disclosures for SunTrust.
Before applying for a private student loan, SunTrust recommends comparing all financial aid alternatives including grants, scholarships, and both federal and private student loans. To view and compare the available features of SunTrust private student loans, visit https://www.suntrust.com/loans/student-loans/private.
Certain restrictions and limitations may apply. SunTrust Bank reserves the right to change or discontinue this loan program without notice. Availability of all loan programs is subject to approval under the SunTrust credit policy and other criteria and may not be available in certain jurisdictions.
SunTrust Bank, Member FDIC. ©2019 SunTrust Banks, Inc. SUNTRUST, the SunTrust logo and Custom Choice Loan are trademarks of SunTrust Banks, Inc. All rights reserved.
6 Important Disclosures for LendKey.
Additional terms and conditions apply. For more details see LendKey
7 Important Disclosures for CommonBond.
A government loan is made according to rules set by the U.S. Department of Education. Government loans have fixed interest rates, meaning that the interest rate on a government loan will never go up or down.
Government loans also permit borrowers in financial trouble to use certain options, such as income-based repayment, which may help some borrowers. Depending on the type of loan that you have, the government may discharge your loan if you die or become permanently disabled.
Depending on what type of government loan that you have, you may be eligible for loan forgiveness in exchange for performing certain types of public service. If you are an active-duty service member and you obtained your government loan before you were called to active duty, you are entitled to interest rate and repayment benefits for your loan.
A private student loan is not a government loan and is not regulated by the Department of Education. A private student loan is instead regulated like other consumer loans under both state and federal law and by the terms of the promissory note with your lender.
If your private student loan has a fixed interest rate, then that rate will never go up or down. If your private student loan has a variable interest rate, then that rate will vary depending on an index rate disclosed in your application. If the interest rate on the new private student loan is less than the interest rate on your government loans, your payments will be less if you refinance.
If you don’t pay a private student loan as agreed, the lender can refer your loan to a collection agency or sue you for the unpaid amount.
Remember also that like government loans, most private loans cannot be discharged if you file bankruptcy unless you can demonstrate that repayment of the loan would cause you an undue hardship. In most bankruptcy courts, proving undue hardship is very difficult for most borrowers.
8 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|4.23% – 13.23%1||Undergraduate and Graduate|
|4.20% – 11.44%2||Undergraduate, Graduate, and Parents|
|4.84% – 13.49%3||Undergraduate and Graduate|
|4.50% – 10.11%*,4||Undergraduate and Graduate|
|4.25% – 13.25%5||Undergraduate and Graduate|
|5.85% – 6.99%6||Undergraduate and Graduate|
|3.95% – 9.81%7||Undergraduate, Graduate, and Parents|
|4.45% – 12.42%8||Undergraduate, Graduate, and Parents|