In 2001, I graduated from college with about $22,000 in student loans. The bulk of my debt ($20,000) was from a federal loan, but I also had a small $2,000 private loan.
Despite the fact that my private loan was a tenth the size of my federal loan, it was the much bigger headache producer in the year and a half it took me to get it paid off. My lender raised my payment once without notice, as well as increased my interest rate. Though my payment amount was low (about $60 per month), I decided to just quickly pay off the entire loan to avoid the stress-inducing changes that seemed to crop up every six months.
Thankfully, that was my only private student loan, and I’ve since paid off all of my loans. Some private loans, however, are more difficult to recover from.
Here’s the fine print you need to know about private student loans:
The Rates Aren’t What They Seem
You might be tempted to go for a private student loan over a federal loan because the advertised interest rates are so much lower. But remember, those ads are just that: advertisements intended to lure you into borrowing.
Private loans, unlike federal loans, require underwriting. That means the bank providing your private student loan will assess the risk of lending you money. Because of that, those low rates aren’t going to be available to every borrower — only those with the best credit. In addition, most private loans offer variable interest rates, rather than the fixed rates of federal loans. This is why my rate changed back in 2002.
You’re Putting Your Cosigners At Risk
Most private loans will also require a cosigner with the student. That means the cosigner (generally Mom or Dad) will be putting their credit at risk if Junior defaults. And a default is more likely, since private loans don’t offer the myriad repayment and deferment options available to federal student loan borrowers.
Grieving mother Angela Smith was in the news last year because her son’s private lender is intent on collecting the remaining $30,000 of his student debt from her — despite the fact that the young man was murdered in 2008.
Smith cosigned on a private loan with her son, and private lenders aren’t required by law to discharge a loan after a borrower dies. Unfortunately for Smith, it wasn’t made clear to her and her son that she’d be responsible for the student loan payment in the event of his death.
Even without a tragic end to a student’s life, cosigners are still in for potential collections calls and harassment — not to mention a hit to their credit — if the student finds herself unable to pay.
You May Fall Victim to Repayment Shenanigans
If you have more than one loan through the same lender, you might try to get your highest-rate private loans paid off first in order to maximize your payments. However, the Consumer Financial Protection Bureau has found that loan servicers (the companies hired by private lenders to collect payment) don’t always let you use this very sensible strategy.
The CFPB has found that servicers will often divide overpayment and apply it to all of the outstanding loans, meaning it’ll take the borrower longer to pay them back.
This is also a problem for any borrower who’s fallen behind in payment. Lenders will generally tell such a borrower to pay as much as they can afford — but that payment will be applied evenly to all of the loans, rather than just the highest-rate loan. This increases the late fees and other penalties the lender can place on the borrower, as well as worsen the impact on the borrower’s credit.
The Bottom Line
Private student loans can potentially be helpful in making the cost of college attainable. That being said, students are likely to have a better experience with federal student loans and should walk into a private student loan with their eyes wide open.
Do you (or did you) have private student loans? Have you run into any of these problems?