Private Student Loans: What They Are, How They Work

What Is a Private Student Loan?

Private student loans are loans taken out for higher education that are offered through third-party providers. They can be used to pay for tuition and fees at two-year colleges, four-year institutions of higher education, trade schools, and other adult education centers, depending on the lender.

Private student loans can be offered through banks, credit unions, state agencies, and even schools themselves. They can be fixed-rate loans that are repaid in regular installments or variable-rate loans in which payment amounts can change. Learn more about how private student loans work.

How Private Student Loans Work

Private student loans can differ heavily depending on the lender, and they're typically best used after federal student loans have been exhausted. Private student loans have more flexible maximum loan amounts, including the option to borrow up to the cost of tuition and fees to attend school (minus any financial aid received).

Private student loans can come with different repayment terms depending on the lender, but they can often be repaid over 10 to 15 years or longer. Some private student loans also offer interest-only payments for a set period of time or flat payments during school to help keep interest costs at bay. Most private student loans also let students defer payments until after they graduate, although more interest accrues over time for students who go this route.

Student loan interest rates vary among private lenders, and the rate that applicants ultimately qualify for can depend on their creditworthiness. This makes private student loans different from most federal student loans, which are available to borrowers regardless of their credit. Where many private student loans feature variable interest rates that can change over time based on market conditions, some private student loans have fixed rates. 

Private vs. Federal Student Loans

While private student loans are offered through third-party companies and have more variables as a result, federal student loans are made through the government. This means the terms and conditions of federal student loans remain constant because they're set by law. 

These factors tend to make federal student loans less expensive than private student loans over the long term, especially when students repay their debt using IDR plans that base their monthly payments on their income and family size.

The main differences between private and federal student loans are highlighted in the chart below.

Benefits of Private Student Loans

Flexibility in Loan Amounts

While federal student loans come with limits that dramatically impact how much students can borrow in each year of school, private student loans can provide larger loan amounts. In fact, many private loans let students borrow up to 100% of the cost of attendance for each year of school, minus any financial aid they receive.

Competitive Interest Rates

Private student loans can come with competitive interest rates that make borrowing for school relatively affordable. However, the best interest rates and loan terms go to borrowers with very good to excellent credit.

Streamlined Application Process

Students can apply for private student loans online and from the comfort of home. Many private student loan applications can be completed in five minutes or less.

Co-Signer Options

Another benefit of private student loans is the fact students can qualify for lower interest rates and better loan terms with a co-signer. This can be especially helpful when the borrower has a parent or another family member with great credit who's willing to co-sign.

Drawbacks of Private Student Loans

Lack of Federal Protections

Private student loans don't give you the chance to qualify for future loan forgiveness via IDR plans, nor do they offer federal deferment or forbearance. If the government is ever able to pass broad student loan forgiveness in the future, there's a good chance it would only apply to federal student loans.

Variable Interest Rates

Many private student loan options come with variable interest rates that can fluctuate over time based on market conditions. While variable rates can lead to potential savings when interest rates are low, your monthly loan payments could surge in a rising interest rate environment.

Credit Requirements

While most federal student loans are available to borrowers without a credit check, the same cannot be said for private student loans. The best private student loan rates go to borrowers with very good credit or better, and borrowers with imperfect credit pay much higher borrowing costs.

When Should You Consider a Private Student Loan?

Private student loans make the most sense when any of the following applies:

• You’ve exhausted federal student loan limits but still have additional higher education expenses to cover.
• Your income is high enough that you don't qualify for any financial aid or assistance.
• Your future income will be high enough to repay what you borrow without the federal benefits and repayment options afforded to federal student loans.
• You have the credit score and history to qualify for private student loans with the best rates and terms.
• You have a co-signer with strong credit and a lengthy credit history.

Applying for a Private Student Loan

Researching Lenders

Research and compare the best private student loan companies based on their interest rates, repayment options, and loan amounts. Be sure to read over the product pages for loan products you're considering, and check for hidden fees like prepayment penalties or application fees.

Application Process

You can apply for a private student loan online. You should plan to submit information like your full name and address, Social Security number (SSN), monthly income, year of school, the degree you're pursuing, and more. You may also be asked to choose the loan amount you need and your desired repayment plan during the application process.

Loan Disbursement and Repayment

Once you're approved for a private student loan, you can receive the funding in one of two ways. Some lenders will send the loan funds directly to you so you can use them for tuition and fees, whereas others will send the money to your school directly.

Tips for Successfully Borrowing a Private Student Loan

To get the most out of your private student loan experience, consider the following:

• Understand loan terms and conditions: Read over the terms and conditions of your private student loan before you sign on the dotted line. Make sure you’re aware of details like when you'll need to begin making payments, your interest rate, whether your rate is fixed or variable, and your total loan costs over your chosen repayment term.
• Borrow only what you need: Only borrow the minimum amount you need to get through school. If you borrow more than you need and spend it on expenses that aren't required for higher education, you may live to regret it.
• Take repayment seriously: Remember that student loan repayment can have a dramatic positive (or negative) impact on your credit score. Making on-time payments on your loan each month can help you build credit, whereas paying late can cause considerable harm to your score in a short amount of time.

Alternatives to Private Student Loans

If you need to pay for school but you're not necessarily sold on private student loans, consider these alternatives.

• Federal student loans: You can apply for federal student loans by filling out the Free Application for Federal Student Aid (FAFSA) each year. These loans come with fixed interest rates and flexible repayment terms, and you should exhaust them before you borrow with a private lender.
• Scholarships: Apply for scholarships that can help you pay for school. You can look for these opportunities through colleges themselves, professional groups, employers, and online scholarship search engines.
• Grants: Various grants can also help pay for higher education. You may find out about federal grant options you're eligible for when you fill out the FAFSA.
• Part-time job: You can also work while you're in college to help pay for school and living expenses. It may even be possible to find employment with your college or university.

The Bottom Line

Private student loans offer a way to fund a college degree, but their less favorable terms mean they should only be used once federal student loan limits have been exhausted. Even then, it's important to only borrow what you need with private student loans so you don't wind up with too much student debt. Additionally, make sure the earnings in your future career will justify how much you need to borrow to graduate.