Private Student Loans: When Federal Student Loans Aren't Enough

Though federal student loans, such as the Federal Stafford Loan, help many students to attend college, families often find that even the maximum loan amounts are not enough to pay for their education. For instance, the average cost of college the 2021 - 22 academic year is $35,331— yet the most money first-year college students can borrow under the subsidized Federal Stafford Loan program is only $5,500!

How do families close that gap?

According to Educationdata.org, student loans (tied with college savings plans) are the third way students use to pay for college. Private student loans are considered the fastest growing component of funds used to finance college. But just what are “private loans?” In the education world, colleges often refer to loans made directly by banks and other lending organizations as “private” or “alternative” loans in order to distinguish them from federal loans. Private loans can be used alone or to supplement federal loans. Technically, they are consumer loans that can be used for education purposes. As with other consumer loans, borrowers must demonstrate that they meet credit guidelines. For students who often have limited or no credit history, like students, a creditworthy cosigner may be needed. What sets education consumer loans apart from other consumer loans is that collateral is not required to secure the debt, and in many cases, repayment of the loan can be postponed while the student is in college.

What’s the difference between federal and private loans?

The main difference between federal loans and private loans is that the government “guarantees” federal loans against default. If a borrower defaults on repaying a federal loan, the government repays a portion of it. Many lenders actually provide the funds for both federal and private education loans. Because there is less risk to a lender with a federal education loan, interest rates are generally lower for those loans than for private loans— for which a lender assumes all risk that the loan will be repaid.

Federal vs Private Student Loans

Federal Loans

Financial aid forms required

Loan limits determined by grade level

Schools must authorize the loan amount

Funds are sent to the school

Satisfactory Academic Progress required to receive additional loans

Standard 10-year repayment term

Restrictions on how loan may be used

Private Loans

Financial aid forms not required

Higher loan limits

Faster application process

Funds may be sent to borrower

Longer repayment terms

Repayment options

Less restrictions on how the loan may be used (as for a computer for college or transportation)

How do families know if they should choose a private loan?

For those families who find that a federal student loan isn’t enough, there are several options. Parents may consider a Federal Parent PLUS Loan (Parent Loan for Undergraduate Students). PLUS loans are made in a parent’s name, but unlike student loans, repayment generally begins immediately after receiving the loan. For families who prefer that students receive the loan in their own name, a private loan may be the answer, and there are several private loans available today. Some require that the school authorize how much a student may borrow and some do not. Other private loans allow a student to postpone all payments of both principal and interest, and some will require at least interest-only payments while in college. Some allow for fast loan application and pre-approval by phone or online. Finally, some send the loan funds to the school and some send the funds directly to the borrower. Before selecting a bank or other lending institution for a private loan, determine what your needs are, then find the private loan product that best meets those needs. And though “education pays” in higher income earnings by educational attainment, remember to borrow only what’s necessary to help keep your loan repayment manageable.

How can a family make smarter student borrowing choices?

There are a few unspoken rules to borrowing that can make a huge difference in the amount of student loan debt that a college graduate leaves school with.

Borrow federal student loans first.

Though there is a limit to the dollar number students can borrow per year from the federal government, it still makes sense to borrow federal loans first. Of the student loan options, these are the cheapest. They have the lowest interest rates. Some students may also qualify for subsidized student loans. These are for students that demonstrate financial need. During a student’s college years, the federal government will actually pay the interest on the student loan, saving the student money on their student loan debt.

Never borrow more than the starting annual salary.

Students should never borrow more money than they can realistically pay. A good rule of thumb is to never borrow more than the expected annual salary upon graduation – or more than the parents make annually. Many students don’t know what they will be making after graduation. What they can do is look at the average starting salary for college graduates to determine their ceiling for student borrowing. Monster provides a tool for soon-to-be college grads that uses their college major to predict their future salaries. From a list of eight majors (computer science, engineering, math and sciences, social sciences, business, agriculture and national resources, communications, humanities) the average starting salary for the Class of 2022 is $62,800, according to National Association of Colleges and Employers data. Students can also search for annual expected salaries by field. Perhaps they know that they will be majoring in English or Engineering, looking at the salary for recent graduates in both of those fields will enable students to make smart student loan decisions.

Exhaust all options when paying for college.

In order to limit the amount of student loan debt taken on to pay for college, students can utilize other options. These include:

Work Study jobs on campus

Part-time jobs off campus

Scholarships

Tax Credits

Work study and part-time jobs can be found once a student arrives on campus. Even if the student didn’t qualify for a work study job through financial aid, there still may be open positions on campus that will open up to all students. Work-study jobs allow students to get paid while maintaining a flexible working schedule. Part-time jobs are available off campus and can provide more than just a paycheck. Many part-time jobs come with the added benefit of employer tuition assistance. These provide a great alternative to paying for college. When it comes to scholarships, many students stop searching after their senior year of high school. What they don’t realize is that there are thousands and thousands of scholarships for college students. By continuing the scholarship search through college, students can find more options to help them pay their tuition bill. Tax credits are another option that students and parents can utilize to pay for school. During tax season, individuals and families can qualify for tax credits by being enrolled in college. These tax credits can be used to pay for student expenses. When it comes to paying for college, students must get creative in order to limit the amount of student loan debt they have after graduation. This isn’t to say that student loans are bad; in fact, they are very helpful. Students just need to ensure that they are making smart borrowing choices and not loading themselves up with student loan debt that is difficult to pay back. To get started on the student loan journey, check out Fastweb’s Guide to Student Loans.