7 Reasons Private Student Loans Can Be Bad News for Borrowers

graduation cap on pile of change
Source: iStock

Nearly 70% of people who graduated from college in 2013 had student loan debt, according to the Institute for College Access and Success. While many students borrow money through the federal student loan program, a significant number — 1.4 million in the 2011-12 school year — turn to loans from private lenders to finance their education. And that can be a big problem.

“If you must take out student loans, federal student loans are the best option for the vast majority of borrowers,” says the Consumer Financial Protection Bureau. That’s because private student loans tend to be more expensive and have less flexible terms than federal loans.

Yet many students aren’t taking full advantage of the federal student loans available to them. Twenty-eight percent of people with private student loans weren’t borrowing as much as they could have via federal student loans. Another 19% had no federal loans at all, the Institute for College Access and Success found.

For some students, private loans make sense. Graduate students may have no choice but to borrow money privately if their tuition and fees exceeds the limits for federal student loans. And in some cases, private student loans may be cheaper for borrowers with great credit scores.

But for the majority of students, especially undergraduates, private student loans should be the last choice when it comes to paying for college, used only after exhausting all options, including grants and scholarships, federal loans, and paying tuition yourself. Here are seven reasons why borrowers should approach private student loans with caution.

student loan application
Source: iStock

1. You may need a co-signer

Many undergraduates won’t be able to qualify to a private student loan on their own. If that’s your situation, you’ll need to find a co-signer (usually a parent) who will agree to be responsible for the loans if you can’t repay the debt.

Having a co-signer can make it easier to get a loan or a lower interest rate. But it comes with risks for whoever offers to help you out.

“Sometimes parents are under the impression that all loans in the financial aid package are loans that the student is responsible for and are shocked later when they realize that they are solely or equally responsible for the loans,” Wan McCormick, a financial planner at Reliable Alliance Financial, told U.S. News & World Report.

2. You may have to make payments while you’re in school

When you borrow money through the federal student loan program, you don’t have to make payments if you are enrolled in school at least half-time. If the federal loans are subsidized, no interest accrues while you are attending . If the loans are unsubsidized, interest accrues, but you don’t have to make payments. That’s not the case with private loans.

Depending on the terms of your private student loan, you may have to make payments while you are enrolled in college, though some private student loan lenders may offer deferment options that are similar to those offered by the federal government. Make sure you understand when you’ll be required to start making payment before borrowing money.

Source: Thinkstock
Source: Thinkstock

3. They generally charge higher interest

Private loans are often more expensive than federal loans, especially for borrowers who don’t have great credit. Interest rates may be as high as 13%, according to the Institute for College Access and Success. In comparison, current interest rates on federal student loans range from 4.29% to 6.84%, regardless of the borrower’s credit history.

“[Private student loans] have much more in common with credit cards than they do with federal student loans,” claims the Institute.

4. Your interest rate may go up

Some private student loans charge a variable interest rate, which means the interest rate adjusts when the underlying benchmark index changes. “Variable interest rates tend to start lower than fixed interest rates, but may increase over the life of the loan,” notes Discover Student Loans.

If you have a variable rate loan, your rate may adjust every quarter or every month. That means that your monthly payment may change and you could end up paying more in interest over the life of the loan.

Federal student loans have fixed interest rates that don’t change over the life of your loan (unless you consolidate all your federal loans into one single loan).

5. You won’t be eligible for certain loan forgiveness programs

The federal government offers loan forgiveness programs for people who work in public service or as teachers. Remaining loan balances may also be forgiven for borrowers who sign up for income-driven repayment plans and have not paid off all their debt after 25 years.

Private students loans can’t be discharged or forgiven under these programs.

student loan repayment
Source: iStock

6. The repayment options may not be as flexible

If you have trouble paying back your federal student loans, you may be able temporarily stop making payments. Or, you could lower your monthly payment by choosing an income-based or extended repayment plan. Private student loans may not come with the same flexibility.

“The last thing students who may be in a tight spot want to hear is that they either cannot place loan payments into a deferment or forbearance for temporary relief,” Rachel Myers, communications coordinator at the Liberty University financial aid office, told U.S. News & World Report.

A few lenders, including Wells Fargo and Discover Student Loans, have started to offer loan modifications to borrowers who are having trouble paying their debt. Borrowers facing financial hardship may be eligible for lower interest rates or interest-only payments in certain circumstances, the Wall Street Journal reported.

7. The loans may not be discharged after you die

Most people probably don’t think about what will happen to their student loan debt after they die. If they do, they likely assume that the loans will disappear. But if you have private student loans, your lender may come after your surviving relatives for payment.

If a parent co-signed the loan with you, they will have to pay back the remaining balance of the loan, even if you are no longer living. Private student loan lenders may also try to get your estate to pay off the remaining balance or want your spouse to pay off the debt (if you live in a community property state). In contrast, your relatives can apply to have your federal student loans discharged after your death.

Follow Megan on Twitter @MeganE_CS
Want more great content like this? Sign up here to receive the best of Cheat Sheet delivered daily. No spam; just tailored content straight to your inbox.