Everything You Need to Know About Private Student Loans

College tuitions and expenses are rising steadily. In fact, CollegeBoard predicts that by the end of 2008 the total yearly cost for private four-year colleges and universities will average a staggering $32,307. That marks a 5.9% increase since the 2006-2007 school year. In the past, many students relied on federal loans to pay for college. However, skyrocketing tuition costs and stagnating federal aid have created a pinch--government funds may not provide enough money to cover room, board, books, and tuition. This is where private loans can help.

According to USA Today, private loans represent the fastest-growing sector of the student loan industry. During the 2005-2006 school year students borrowed a record-breaking $17.3 billion from private firms. Before taking advantage of these funds, educate yourself about their potential risks and benefits. Here is a closer look at the pros and cons of private loans.

How are Federal Loans and Private Loans Different?
First of all, federal loans and private loans have dissimilar lending policies. While federal loans are awarded to students who can prove their financial need, private loans are granted to students with a good credit history. Consequently, students and parents with poor credit may pay much higher rates for private loans than those with strong credit. Also, private loans do not carry the federal government's guarantee. Since the government does not set interest rates, private lenders may charge more depending on the demand for funds and the risk profile of the borrower.

Private loans do offer benefits. For example, since the federal government only allows undergraduates to borrow $23,000 in total Stafford loans, private credit can help students pay for costs exceeding that limit. Also, private loan applications are easy to complete and money may be available within days. Since private loan repayment is a serious obligation, it is to your advantage to borrow only as much as absolutely needed.

Would I Qualify For a Private Loan?
Requirements for private-loan applicants typically include:

• U.S. citizenship or permanent residence
• A valid Social Security number
• International students need a co-borrower who is a U.S. resident
• The school must be affiliated with the federal education loan program
• You should not have defaulted on any previous loans
• Your should possess a clean credit record
• Although it is not required, it could help your private-loan eligibility to apply with a co-borrower, even if you are already a U.S. citizen
  

Where Do I Find a Lender?
Various firms grant private loans, including large banks and specialized lending companies. Before committing to a private loan, make sure that it meets your financial needs. Also, if you hope to attend graduate school after finishing college, look for private loans with deferment options. Consider the following when sifting through your private-loan choices:

• Do I need someone to cosign for the loan?
• Can I obtain a lower interest rate with a co-signer?
• How much can I afford to borrow and what will my payment be?
• When do I have to begin repayment and how long will it take?
• Will I be penalized for paying off my loans early?
• What is the loan's interest rate and how is it calculated?
• Which factors are considered when calculating the loan's interest rate?
• What fees will I be charged?

When you have found a lender that seems like a good fit, contact a loan agent for pre-approval or complete an online application. The Truth In Lending Act (TILA) requires that the lender disclose the rate and fees when you apply for your loan. Read it carefully--the rate and fees on that form is what you will be committing to pay--not what you may have been told in an informal conversation with an agent.

While online applications aren't required to obtain a loan, most lenders and schools prefer that you apply online due to the increased processing speed. After you have finished your application, your lender should contact you for any additional information. When your file is complete and your loan is approved your private lender should notify your school to make your money available.

How Do I Repay the Loan?
Repayment options differ from lender to lender. The typical repayment plan involves a monthly payment, which could change if your interest rate is not fixed. Make sure that you fully understand your lender's terms before committing to a repayment plan. Also, if fixed monthly payments do not work for you, you may be able to pay on a graduated scale, starting with a lower payment that slowly increases over time to match your (hopefully!) growing income.

When choosing a repayment option, don't forget that longer-term loans accrue more interest. Although a 25-year loan with small monthly payments may seem attractive at first, long-term loans can result in more interest charges over the life of the loan. A long term loan that you can pay off early offers flexibility; you can start with low payments and voluntarily increase them when you can afford to.

Do Alternatives to Private Loans Exist?
Besides standard federal aid options and private loan choices, prospective undergraduate students can also take advantage of the federal Parent Loan to Undergraduate Students (PLUS) program. The PLUS program lets parents take out a loan for their dependent child. Perks of PLUS loans include a fixed interest rate of 8.5%, the ability to secure a loan that completely covers a student's tuition costs, and more relaxed credit standards than private loans. PLUS loans are best suited for borrowers who:

• Need more than ten years to repay a loan
• Prefer generous loan deferment and forbearance options
• Favor fixed interest rates over variable interest rates

There is also a PLUS program for graduate students with similar benefits. In this case, the student, not the parent, is responsible for repayment.

Due to their fluctuating interest rates and potentially higher costs, private loans should be considered a last resort. Before taking out a private loan, exhaust your options in federal grants, government loans, work-study options, personal funds, and private scholarships. If you don't feel knowledgeable enough to comfortably evaluate private loan packages, try discussing the terms of a private loan with your university financial-aid counselor before making a final decision.