When available financial aid and federal student loans are not enough to cover the total college costs, many families turn to private student loans. These loans can be a useful way to cover the gap, but they are not all created equal.
When you are considering private student loan debt, use these decision-making tips.
Understand how student loan interest accrues.
- Student loans accrue interest on a daily basis. Even if the borrower is not required to make payments while in school or for a period of time after leaving school, interest is accruing, so the repayment amount is more than the original loan amount.
- Capitalization, or the addition of accrued interest to the principal balance, occurs in specific circumstances. According to the terms outlined by the loan’s credit agreement or promissory note, any unpaid interest will be added to the principal balance at specific times. When unpaid interest is added to the principal, interest begins to accrue on new balance, meaning that interest will be paid on interest.
- Generally, payments are applied to any unpaid, outstanding interest with any remaining payment amount going toward principal. If a payment is not enough to cover all outstanding interest, the unpaid portion of interest is carried over to be paid by the next payment.
- Increases to the loan balance may be prevented by payments that at least cover interest any time they are not required, such as while the borrower is in school. Most lenders allow prepayment of any amount without penalty.
Know your comfort level with interest rates.
- Would you prefer a fixed or variable rate? A fixed rate is set for the life of the loan regardless of market conditions, helping ensure payment amounts remain constant. A variable rate may go up or down, sometimes dramatically, during the life of a loan, causing corresponding changes to payment amounts.
- Is it important to know the interest rate before submitting the application? Some lenders provide only a range of available rates before the loan application is processed; others specify the criteria to receive specific rates. In either case, the borrower is able to decline a loan and reapply elsewhere if not satisfied with the rate received.
Borrow only what you need.
- The college or university provides a information about the cost of attendance that generally includes estimated amounts for items not billed directly by the school. Because they are estimates, they may not be the amount your family will actually need to pay. Consider your personal circumstances when applying for a loan so you don't borrow more than you really need.
- Even if you feel you need it to cover remaining college costs, it's generally recommended to not borrow more in total for college than a realistic first-year salary. If you are in danger of borrowing more than that, consider earning more money or cutting expenses.
Be aware of fees and underwriting and credit criteria.
- Read any information about what types of fees are assessed and when. Will an origination fee be charged when the loan is received? When do late fees kick in?
- These fees are separate from the interest rate. An origination fee is a one-time expense; late fees are only assessed for payments made after the due date. Interest is charged on the balance of the loan until it is paid off. Compare the annual percentage rate (APR) between loans for a more accurate picture.
- Some lenders publish more information about their underwriting and credit criteria than others do. If you are unable to find details about the types of borrowers who qualify for loans or specific rates, contact the lender for more information.
Some loans carry benefits for the borrower or cosigner.
- Borrower benefits, such as a reduction in interest rate or the ability to release a cosigner from payment obligation, are sometimes earned by making a certain number of on-time payments, setting up automatic payments or another qualification.
- Make sure you understand all eligibility requirements for benefits, including reasons for losing them. A payment received even a day late could be enough to end benefits.
Consider the broader picture.
- Beyond the specifics of a particular loan, think about the lender. You or your student will likely be working with this lender for many years after leaving college while repaying the debt. Does the lender service its own loans, and does it have a good reputation for customer service?
- Does the lender offer refinancing for student loans? As market conditions change, you may wish to consider refinancing to save money over the long term, and staying with the same lender or servicer can make repayment more convenient. Some lenders offer the ability to refinance loans before graduation.
- Other considerations might be whether the lender is focused solely on student loans or is likely to try to market other items like credit cards to you or your student in the future, as well as whether the lender reinvests in the community through employment, nonprofit endeavors and education about student loan debt and products.