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Why private student loans deserve a (careful) look

Filling a gap? Know your loans

Students and parents are often told to avoid private student loans because of higher costs and less flexible repayment options. This information is beneficial, as federal student loans are always the best option for student borrowers. However, many Iowa students will find that scholarships, grants, and federal student loans fail to cover all their costs. Private student loans — which are made by a lender such as a bank, credit union, or entities such as Iowa Student Loan — can close gaps in financial aid packages. 

If you are considering taking out a private loan, do your homework first. Know your credit score and how it will affect the loan terms you’re offered. Learn the pros and cons of having a parent or other relative co-sign a loan — most students won’t get a private loan without one and having a credit-worthy cosigner can result in better loan terms. Ensure you understand all the terms and agreements before signing. Speaking with the financial aid office at your school or other trusted financial expert can help sort out a complicated selection process.

And shop around: Differences in fees, interest rates, repayment terms, and borrower benefits can make some loans a better choice than others. When comparing private loans consider three important factors: transparency, the cost of the loan, and repayment.

Transparency 

What do you know and when will you know it?

A lender may withhold many of the most basic terms associated with a private loan until after a borrower has completed the loan application. You may discover that the interest rate you’re offered is well above the “teaser” rate that was advertised. Know your credit score so you can shop around and negotiate with lenders. Look for a lender that offers detailed loan information up front to maximize your chances of finding the best loan for you. 

Cost of the Loan

How much does it cost to take out a loan?

A lender will often assess origination fees when a loan is first disbursed to pay for the costs of processing the loan. These fees usually take the form of a percentage of the amount borrowed. Look for low- or no-origination fee loans.  Some lenders may have other fees they charge, either up front or after you’ve entered repayment.  Ask any potential lender for a complete list of fees associated with the loan you’re considering.

What type of interest rate?

The Annual Percentage Rate (APR), rather than the interest rate itself, is often the most important number to consider when comparing loans, as it takes into consideration other fees that add to the overall cost of the loan. Students borrowing with a credit-worthy cosigner will generally qualify for a lower interest rate.

Private loans can come with fixed or variable interest rates. Fixed-rate loans offer a stable repayment with monthly payments that remain the same over the life of the loan.  Variable-rate loans may offer a lower initial interest rate, but an increase in the relevant index (LIBOR, prime, etc.) can cause the interest rate to go up, which will make the monthly payment increase, as well. 

How does interest accrue and capitalize?

The questions could have a big impact on your costs: Will interest accrue while the student is in school? When will the accrued interest be capitalized, or added to the principal balance of the loan? Monthly capitalization (where accrued interest is added to the principal balance every month) is the most expensive kind, and should be avoided when possible.  Borrowers and cosigners should consider making interest-only payments while in the student is in school.
Paying off interest as it accrues can help keep the overall cost of your loan down by preventing interest from capitalizing.  

Repayment

When does repayment start?

Many private loans require borrowers to begin repayment shortly after the loan is disbursed, while some allow borrowers to postpone repayment until after they have left school.  Delaying repayment can end up costing a borrower more in accrued interest, but may be necessary if the borrower is a full-time student with limited income.

What benefits are offered?

Some private loans include provisions that can reduce the overall cost of the loan.  These benefits can include an interest rate reduction for making monthly payments via automatic debit from a bank account, or successfully repaying the loan for a fixed number of months without a late payment. Some lenders offer to remove a co-signer, but ask for details regarding the removal criteria and process, as well as the number of loans for which this has happened, before assuming co-signer removal will be possible.


What help does the borrower receive?

Repayment often lasts decades, so it’s important to consider what you can expect for customer service before you borrow. Ask any potential lenders for information on whether your loan will be sold after origination or at the time of repayment, or if they service their own loans.  Customer service during the borrowing process can give you a good idea what you can expect during repayment.    

Before you borrow, look into forbearance and deferment options.  If you encounter a financial hardship, will a lender charge you a fee to temporarily suspend repayment of your loan?  Also, ask about any other fees associated with modifying the terms of your loan during repayment and what options you have should you have difficulty repaying the loans.

The financial aid office at your school and friends and family may be a good resource for understanding the quality of customer service provided a lender.  Internet searches may also yield valuable insights into other borrowers’ experiences. 

Under Iowa law, lending institutions must disclose some of the information covered above on private student loan applications. To learn more, go to the Iowa Attorney General’s website. 

Alternatives to Private Education Loans

Before borrowing a private education loan, Iowa families should consider all less costly options, including monthly payment plans through the college or university.  Many institutions offer a low- or no-fee payment plan that breaks up the balance due for the academic year in to more manageable monthly payments. 

Federal parent PLUS loans have less stringent credit criteria than private loans, but currently carry a hefty 4.248% origination fee, in addition to a 7.6% interest rate, which can make it more expensive for credit-worthy borrowers than borrowing a private loan on behalf of their student. However, families who have trouble getting credit from a private lender may find the PLUS loan to be a possible solution.  

Whether borrowing a PLUS loan or co-signing on a private loan, families should understand the terms of the loan, including who is liable for its repayment.  Loans borrowed by a student, but co-signed by a parent, can affect both of your credit scores if payments are late or the loan defaults.  Additionally, if a borrower defaults on a private education loan, the co-signer is responsible for the full amount of the loan.

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