Private Student Loans Rarely Make Financial Sense

With interest rates on federal student loans set to rise for borrowers who attend college during the 2022-23 academic year, it’s only natural to wonder if you could score a cheaper loan rate elsewhere. After all, private student loan companies are still advertising variable rates as low as 1.19%, and even fixed rates as low as 3.49%. With these kinds of rates still available, you may be inclined to skip filling out the FAFSA and go with private loans instead.

That said, college students and their parents should really think twice before they take out private student loans over federal loans, or at all.

The reality is, there are major benefits that come with federal student loans that you don’t get when you borrow from an independent lender. Plus, private loans make it considerably easier to borrow, over-borrow, and borrow some more for a college education and may or may not even be worth it in the end.

While private student loans can be helpful if you actually need them to pay for college, they rarely make sense as a first choice. Here’s why.

Lack Of Access To Hardship Options

First off, you may be aware that interest rates have been set at 0% and payments have been paused for federal student loans since March of 2020. This emergency deferment period, which was brought on due to the pandemic, is currently set to expire on August 31, 2022. However, the emergency deferment can (and probably will) be extended yet again, which means borrowers will likely get even more time with zero interest and no payments on federal student loans.

Like other forgiveness measures, including regular deferment and forbearance options offered by the government, this temporary student loan payment holiday only applies to federal loans — not private. In fact, borrowers with private student loans have been on the hook for payments and interest since the pandemic began.

And while some private lenders have offered short terms deferment and forbearance options, none of them have included 0% interest, and none have lasted years like the Federal pause has.

No Loan Forgiveness For Private Student Loans

You may have also heard that President Biden plans to forgive some amount of student loan debt for eligible borrowers through executive action in the coming months. It’s rumored that the amount forgiven will be around $10,000 per person with student debt, which would completely wipe out the loans of about one-third of student loan borrowers nationwide.

There will likely be income caps on any forgiveness plans for student loans that come to fruition, however, which will limit who can qualify. Either way, it’s more important to note that any forgiveness offered will only apply to federal student loans and not to private loans.

Also note that most other student loan plans that lead to forgiveness are only for federal loans. This includes teacher loan forgiveness programs, various state-based loan forgiveness programs for borrowers who work in public service, and of course Public Service Loan Forgiveness (PSLF).

Income-Driven Repayment Is For Federal Loans Only

Private student loans are also ineligible for income-driven repayment plans, which have become incredibly popular over the last few years. Income-driven repayment plans like Pay As You Earn (PAYE) and Income Based Repayment (IBR) let you pay a percentage of your discretionary income toward your loans for 20 to 25 years before forgiving remaining balances. Borrowers with really low incomes can even owe monthly payments as low as $0 toward their loans during the program.

It’s important to know that forgiven amounts through this program are treated as taxable income in the year they’re forgiven, which can lead to a student loan forgiveness tax bomb (which is currently paused through 2025 and may be extended). Either way, having private student loans means you’re not eligible for income-driven repayment at all.

Private Loans Make Over-Borrowing Easy

Most federal student loans come with annual loan limits that cap how much you can borrow for each year of school. While these caps may force you to get creative with college financing, they hopefully lead you to take steps you probably should take anyway — things like choosing a more affordable college, earning side income to fill in funding gaps in school, and using savings you have to pay for college tuition and fees.

On the flipside, many private student loans do not have the same caps, thus they can make it easy to overspend. In fact, many private lenders will let you borrow up to 100% of school certified costs of attending college minus other financial aid received.

Private Loans Require Good Credit

Another downside of private student loans is that they typically require good or excellent credit — something borrowers in college are unlikely to have. Without a good credit score, you are more likely to pay interest rates that are on the high side of those advertised by student lenders online.

Plus, 90% of private loans end up having a cosigner – simply because the primary borrower (i.e. the student) doesn’t have the credit to get approved by themselves.

As such, there are risks involved in this approach. For example, your cosigner will be as responsible for repayment as you are, and that can lead to problems if you struggle to keep up with your student loan payments in the future.

Fortunately, most federal student loans don’t require a credit check at all, much less a great credit score. The exception is Federal Parent PLUS loans and Federal Grad PLUS loans for graduate students, which do require borrowers to have decent credit.

Variable Rates Leave Students Vulnerable

Finally, borrowers should know that federal student loans come with fixed interest rates. This means the interest rate on federal student loans will stay the same for the entire life of your loan, although you may have different rates for federal loans for each year you attend college.

On the flipside, the lowest rates advertised on private student loans are typically for variable rate loan products. These variable interest rates fluctuate with market conditions, which can leave students at risk when it comes to paying exorbitant rates in the future.

The Bottom Line

While private student loans are easy to apply for and ultimately receive, that doesn’t mean they’re best for your budget or your long-term financial goals. In fact, private student loans leave you with far fewer protections than federal student loans, and they can cost more to boot.

Just because a private student loan offers a lower interest rate doesn’t make it the best choice to pay for college.

Make sure you research all your options before you borrow for school, and know that there will be consequences — good or bad — for whatever you decide.