Pros and Cons of Private Student Loans
If you’re starting, or continuing, your nursing career and need to borrow money in order to pay for your education, you're facing some tough questions: How to pay? What kind of loans to go with? Should you go with private or federal? Does it matter?
With everything you may be juggling right now, you may be tempted to take the easiest route to financing (whatever that may be) so you can move on with your life. But spending some time really understanding your options may save you a lot of money later on.
In this article, we’ll explain:
- The basics of student loans
- What private student loans are
- The pros and cons of private student loans
- How to choose the right loan for you
Student Loans 101
Before taking out any kind of student loan, you need to understand a few important factors.
1) Credit Rating
Your credit score impacts the kinds of loans you can receive from a bank and the kind of interest rate you’ll be offered. If you have great credit, the lender sees you as a low-risk borrower, therefore they may be willing to give you a lower rate when lending you money. For borrowers with not-so-great credit, or who just haven’t built up much of a credit history yet, you can expect a higher interest rate because the lender sees you as less of a safe bet.
The interest rate is the amount you’ll be charged for the money you’re borrowing. These can be either fixed rates or variable rates.
- Fixed Rates: Fixed interest rates are locked in when you sign and cannot change over the course of the loan. They are usually higher than variable rates, but there are fewer unknowns.
- Variable Rates: Variable rates tend to start off lower, but they come with a risk: if interest rates go up, so do those for all variable-rate loans.
Since the Great Recession, rates have only gone downward and borrowers with variable loans have only benefited from them. But the economy is currently in an unpredictable place and no one knows when, or if, we’ll see higher interest rates.
Most private student loan lenders offer a choice between fixed- and variable-rate loans, while all federal student loans have fixed rates.
When Does Interest Start Accruing?
The other important factor you need to keep in mind with interest is when does it start accruing? This depends on the type of loan you took out. With Direct Subsidized Federal Loans (more on those later) you don’t accrue interest while you’re in school and for 6 months after you graduate because the federal government is covering it. With private loans and Unsubsidized Federal Loans, you’ll typically start accruing interest immediately.
The type of lender you go with -- either the government for federal loans or a private lender like a bank -- makes a big difference in the terms and conditions of the loan. We’ll go into that in greater depth later in this article.
Most federal student loans come with loan origination fees that cost a percentage of the loan amount. They exist to pay the costs the lender incurs when issuing the loan. Private loans sometimes have loan origination fees, but can also have additional fees such as application fees, early and late payment fees, payment return fees, forbearance and deferment fees and refinancing fees.
Cosigning a loan is having someone else, like a family member or exceptionally good friend, put their name on the loan with you. Most federal student loans don’t require a cosigner, but a private loan may. If you have low credit and a bank deems you too risky to lend to, you may need to have a cosigner on your loan. If you have a cosigner with great credit, it can get you a lower interest rate.
But (besides your love and gratitude), there are no upsides for the cosigner and some potentially disastrous downsides. If you fall far behind on your payments, they could end up having to pay off your entire loan immediately in one go. And their own credit could take an incalculable hit.
Obtaining loans is one thing, but you also need to consider how you’ll pay them off, how long the repayment period is, and when you’ll need to start repaying them. Most federal loans and some private loans allow you to wait until 6 months after you’ve graduated to begin paying them, but some may not. You need to look over your loan agreement carefully to check these terms.
Private Student Loans vs. Federal Loans
Now that you’ve got the basics of student loans down, let’s explore the differences between private loans and federal loans.
Federal Student Loans Are Often Your Best Option
Federal loans can be a student’s best option in most circumstances. Federal Student loans are loans provided by the US government and they have some benefits built in like fixed interest rates and excellent terms.
Types of Federal Student Loans
There are two main types of federal student loans. According to Peg Keough, College Financial Planning Consultant and Founder of Way to the Quad, “There's subsidized and unsubsidized federal loans. Depending on the parent’s, or student’s, financial situation, they might get a combination or they might just get unsubsidized -- but they're the best ones out there.”
- Direct Subsidized: These are federal student loans that don’t accrue interest while you’re in school because the government is subsidizing them. These are available to students who have financial need. They have fixed interest rates and there’s no minimum credit score required to get them.
- Direct Unsubsidized: These are also federal student loans, but the government doesn’t subsidize your interest, so you’ll start accruing interest as soon as you take out the loan. However, you won’t be required to start paying them off until 6 months after you graduate.
To apply for a federal student loan, you’ll need to fill out the Free Application for Federal Student Aid (FAFSA).
Benefits of Federal Student Loans
Federal Student Loans can come with important benefits including:
- Fixed Interest Rates: As we touched on earlier, fixed rates mean that your rate can’t fluctuate over time. And, as Keough points out, federal rates are really low right now. “For this school year coming up, the interest rate is 2.75%, partially because of what's going on in the country, the Fed has been lowering interest rates.” For undergraduate Direct Subsidized and Unsubsidized student loans disbursed on or after July 1, 2020, the interest rate is fixed at 2.75%, and for graduate students, it’s fixed at 4.3%.
- Financial Protections: The federal government has some financial protections in place to protect borrowers such as the current 0% interest and automatic forbearance happening as a result of COVID-19.
- Repayment Benefits: Federal student loans have a number of repayment benefits built into them that private loans do not. These include things like income-driven repayment plans, and student loan forgiveness options. These are particularly important for nursing students, as there are a number of student loan forgiveness programs available for nurses.
Federal Loan Caps
Federal loans are great, but they have their limits, literally. Federal programs cap the amount you can borrow: In 2020, undergraduate loans are capped at $31,000 for dependent students (those still considered to be dependent on their parents), $57,500 for independent students, with no more of $23,000 in subsidized loans. For graduate students, the cap is $138,500, with a cap of $65,500 in subsidized loans.
Federal loans also have yearly caps in addition to their overall caps. Meaning that you have a set amount of federal loans available to you in your freshman, sophomore, junior and senior years. And if you don’t use them within that year, they’ll disappear. It’s a “use it or lose it” situation according to Keough. She points out that many people think “I have some money in 529, I'm not taking out loans. And then by junior year, it's all gone and they haven't taken advantage of really good loans, freshmen and sophomore year.”
She wants everyone to understand that college is a “four year cash flow” and you have to plan to finance it all. Part of that planning, if your federal loans won’t cover all of your financial needs, is considering private student loans.
Pros and Cons of Private Student Loans
According to Keough, “The key thing about private loans is: Don't make the assumption that they're similar to the direct student loans the federal government's offering. You're getting these from a private bank, a credit union, or Sallie Mae.” Keough adds that some of the main differences are “the interest rates can be variable,” “they usually require a cosigner,” and “there are different things you have to think about that you would never have to think about with the federal loans.”
Pros of Private Student Loans
1. They Can Be a Source of Funding When You’ve Maxed Out Your Federal Loans
As we mentioned above, there are limits to the amount of federal loans you can take out. Once you’ve reached those limits, private loans can help fill the gaps. Many students borrow as much as they can using federal programs, and then switch to private lenders to top up their funding.
2. They Can Be Less Expensive
If you have really good credit, you might be in line for savings by opting for a private student loan. But rates on private loans are typically high for people with poor or fair credit -- and even those at the lower end of the good-credit range. So most are likely better off with federal loans.
As of the date this was written (current rates may be different) highly creditworthy borrowers could get rates as low as 1.24% variable for a new loan and fixed interest rates from 3.75% APR.*
Cons of Private Student Loans
Private student loans do come with some considerable downsides. The main cons of private student loans include:
- Higher rates for most borrowers.
- Fees to set up your loan, though federal student loans come with origination fees as well.
- They lack the protection of sustained income-related payments if you hit hard times.
- They don’t provide loan forgiveness in return for public service, and they don’t discharge or cancel loans in the ways federal programs occasionally do.
- They may start charging interest the moment you receive your funds.
- None of the federal subsidies on interest that subsidized federal student loans have.
- Refinancing federal debt to a private student loan is a one-way street -- You can’t later change your mind and go back to federal funding. But you can refinance existing private student debt to get a lower rate or payment
- You may need a cosigner in order to get a private student loan.
Choosing the Right Loans for You
So, how do you make your student loan decision? Keough recommends weighing all your options, “You should definitely check on private student loans. I've seen people get really good private student loan rates, that have great credit.” She says, “You could find a bank that locks in the interest rate and, if you have great credit because you're an older person and you've been financially responsible up until that point, it could match it.”
If you don’t have awesome credit (or someone willing to cosign your loan), federal loans may be your best option until you reach the limits.
Takeaways: Here’s What You Need to Consider When Getting Student Loans
Whenever you borrow large sums of money, it pays to do so cautiously. Get quotes from multiple lenders and compare them carefully. And remember to check:
- What your rate and monthly payments will be
- Whether the rate you’ll pay is fixed or variable
- If you have to pay fees to set up the loan
- The repayment period
- When you start accruing interest -- While you’re studying, when you graduate or after that
- Whether there’s a chance of loan forgiveness
- What might happen if you later get into financial difficulties and can’t keep up with payments
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