It's no secret that college is phenomenally expensive, and the sticker price rises every year. In fact, college tuition has increased by nearly 1,200% over the past 35 years. For the 2013-2014 academic year, the College Board reports a moderate college budget averaged $22,826 for an in-state public college and $44,750 for a private college. The most expensive colleges cost more than $60,000 a year. Cha-ching!
Obviously, most families don't have that kind of cash lying around, which is why the vast majority of students borrow money to help pay for college. For the most part, there are two types of student loans:
Federal student loans offer significant advantages, including fixed interest rates and income-based repayment plans – which means they are generally less expensive than private student loans. However, when it comes time to pay for college, many students who obtain federal student loans come up short.
When a federal student loan doesn't cover the full cost of college and the student didn't land a substantial scholarship, it's time to search for a private loan.
Offered by banks and private lenders, private student loans generally come with variable interest rates between 3% and 12%, origination fees and other charges. These days, most private student loans mandate a cosigner, especially for younger students who haven't established a credit history.
For these reasons, private student loans are often considered a last resort for families. Even so, with proper research, it is possible to find a competitive loan that meets the student's needs.
Not sure where to begin with your private loan hunt? Here are a few tips:
A Lot Depends on Credit Scores
As you research student loans, pay close attention to interest rates. Unlike federal student-loan interest rates, which are the same for every borrower, the interest rates for private student loans vary. That's because private loans are credit-based; students with better credit scores may receive a more favorable interest rate.
Students with a low credit score or no established credit history should apply with a credit-worthy co-signer, like Mom or Dad. Not only will this increase the chances of getting approved, but it could also significantly reduce the interest rate. Co-signers should be aware of the risk they are taking on, however. See Seniors: Before You Co-sign That Student Loan.
Check Out the APR
As you're shopping around for the best deal, you may be tempted to choose the loan with the lowest interest rate. Don't make this mistake. When it comes to private loans, it's more effective to compare the Annual Percentage Rate (APR). Why? Because basic interest rates may not represent the true cost of the entire life of the loan. The APR factors in account deferment periods and repayment terms, which can have a huge impact on the overall cost of the loan.
To top it off, most lenders won't give you an actual interest rate until after they have a chance to review your application. However, lenders typically provide APR examples up front, which can help you compare loans apples-to-apples. These APR examples also illustrate the lowest and highest interest rates available, which will give you an idea of what you can expect to pay. You're likely to receive an interest rate that lands somewhere between those numbers.
Compare Payment Plans
It's extremely important to find a lender that offers some flexibility when it comes to repaying your private loan. While some lenders require that you start making monthly payments while the student is still in school, others allow you to wait until after graduation. Pay close attention to these details and choose a lender that offers the ideal payment plan for you. For additional information on loan repayment, see Time To Consolidate Your Student Loans?
Study Up on Borrower Benefits
For bonus points, some student-loan lenders offer additional borrower benefits. These might include an automatic-payment interest-rate reduction (the interest rate drops for borrowers who sign up to have loan payments deducted automatically from their bank account), principal reduction or even cash rewards. For example, when you enroll in an automatic payment plan, most lenders will offer anywhere from a 0.25% to 0.50% interest rate reduction. This can translate into hundreds of dollars of savings over the life of the loan.
Be sure to read the fine print about these benefits. If borrowers can't meet their end of the bargain (one month, they miss an auto-payment because their account balance is too low), they could lose the benefit permanently. Read more about the risks and rewards of these benefits here.
Reputation Rules
It's important to choose a student loan lender that has a stellar reputation and offers first-class customer service. Professional and friendly customer service reps will be able to answer all of your complex questions and act as an ally when a borrower needs support and guidance in tough financial times. Not only can they walk students through their repayment options, but they can also help them avoid late payments.
To evaluate the customer service for each lender, ask the following questions:
Most colleges provide a preferred lender list, including contact information for reputable lenders with whom they've worked in the past. These recommended lenders usually offer the most competitive rates and superior customer service. Check out the school's website or ask the college student aid office for a list. For more information, see Top Student Loan Providers and our tutorial on student loans. The website Simple Tuition will also enable you to compare loan options.
The Bottom Line
Families should try for federal student loans first. Private student loans are a last resort when federal loans and other funding (help from grandparents, perhaps) fall short. Research will allow you to compare private loan options and identify the best available deals.
