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Using Private Student Loans to Pay for College

by Student Loan Daddy

Almost two-thirds of students who borrowed education loans either misunderstood or were surprised by aspects of the student loan process, while about 20 percent of students said that the amount of their monthly payments was unexpected, according to a new study.

We’re not quite sure why more college student’s don’t understand the important details of their college financing, but blindly signing on the dotted line for a national average of more than $25,000 in student loans per borrower — and an average of about $76,000 per student in the study — simply isn’t smart. There’s plenty of easily-accessible information about federal student loans, including things like repayment options — after all, there’s only one federal student loan these days. But private student loans are another matter. The loans, issued by banks, can have very different terms. To help, here’s a list of basic information on private student loans to help you ask lenders the right questions.

Exhaust Federal Financial Aid First

When seeking money for college, make sure to exhaust all your federal financial aid options first before considering a private student loan. Fill out the Free Application for Federal Student Aid (FAFSA) which may qualify you for sources of free money for college, such as federal Pell grants, work-study programs, and state and institutional grant-based aid, which won’t have to be repaid.

The FAFSA will also make you eligible for federal student loans, such as federal Stafford loans and federal PLUS loans, which can have better terms, including lower interest rates, more favorable repayment terms and borrower protections, and may offer subsidized interest while you’re in school.

As a general rule, you should borrow the maximum amount of federal student loans before you consider covering any remaining education costs with private student loans.

Private Student Loan Fees, Interest Rates, and APR

Sometimes the fees, interest rates, and APR of private student loans can be confusing. Here are a few pointers:

Interest Rates vs. Fees

Just because a one private student loan might offer a lower interest rate than a federal student loan or another private student loan, that doesn’t always mean the loan will be cheaper. The fees charged by some lenders can significantly increase the cost of a private student loan, which might ultimately cost more than a loan with a higher interest rate and no fees. As a rule of thumb, 3 percent to 4 percent in fees equals about 1 percent in interest.

Beware of Longer Repayment Terms

A loan with a lower APR isn’t always a better choice. Many times, a loan will offer a lower APR but have a longer repayment term, which means you’ll pay a lower rate but will make more loan payments. In the end, a lower interest rate paid over a longer term will usually cost you significantly more money.

Interest Rates Based on LIBOR vs. PRIME

The best private student loan interest rates are based on LIBOR plus 2.0 percent or PRIME minus 0.05 percent with no fees. Unfortunately, these rates, which are based on the creditworthiness of the borrower and his or her co-signer, are available to only about 20 percent of borrowers.

Generally speaking, you should consider a private loan with an interest rates based on the LIBOR index over one that’s based on the Prime Lending Rate, if all other aspects of the loans are similar. Because the spread between the Prime Lending Rate and LIBOR has been increasing over time, a loan based on LIBOR will usually be less expensive than a loan based on PRIME. About half of all lenders tie their private student loans to LIBOR and about 40 percent tie them to PRIME.

It’s worth noting that some lenders use the Prime Lending Rate as a marketing tool simply because PRIME plus 0 percent sounds better to borrows than LIBOR plus 2.8 percent even though that means the rates are the same.

Interest Rates and Grace Periods

Before borrowing a private student loan, make sure you understand how the interest rate relates to any grace period. It’s not uncommon for lenders to advertise loans with interest rates that are lower while you’re in school but that increase as soon as the loan enters repayment after you graduate or leave school.


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