Higher education costs students an average of $35,331 a year, often paid for through scholarships, grants and federal student loans. However, these avenues may not always be sufficient to fund education costs. This is where private student loans come into play, as they can help a student maximize funds for tuition, miscellaneous fees, living expenses and more.
Private student loans, however, should not be the first choice to fund one’s education. The best use of private student loans is to fill in financial gaps only if funds from other sources are insufficient.
Private student loans are loans for education that originate from private lenders, such as banks or credit unions. These typically come with higher interest rates compared to a federal loan.
To qualify for a private student loan, borrowers typically need a decent credit score and to be accepted in a degree program. However, actual requirements may vary based on the lender.
It’s important to apply for a federal student loan, grants, scholarships and other financial aid programs before applying for a private student loan. Generally, private student loans should be the last resort or only used to fill in gaps.
What Is a Private Student Loan?
Private student loans are similar to federal student loans, except they originate from private institutions such as banks, credit unions or online lenders. These private student loan lenders can set their criteria and eligibility requirements, typically credit and income checks or co-signers. Additionally, private student loan limits are based on your college’s cost of attendance minus any financial aid, meaning you may be able to borrow more than you can with federal loans.
Despite this, private student loans are beneficial due to their flexibility, as you can choose how to repay the borrowed amount. For instance, you can choose between variable and fixed-rate loans, and between a five or 20-year term. However, your interest rate and approved borrowed amount will depend on your or your co-signer’s credit score.
How Does a Private Student Loan Work?
If the borrower is approved for a private student loan, the lender will transfer the funds to the borrower's university. The money will then be applied to tuition and other fees, and any leftover is given to the borrower to use for other study-related purposes.
Typically, lenders require a co-signer for undergraduate borrowers, who often lack good credit scores and income. A co-signer is another individual who will agree to repay an applicant’s loan. They become equally responsible and legally obligated to repay the loan, which means any late or missed payments can affect both the borrower’s and the co-signer’s credit scores.
Depending on the lender’s policies, borrowers will not have to pay for their loans while attending school. Typically, deferring your loans while you are enrolled results in payments starting six months after graduation or the date when you drop below half-time. However, interest will still accrue once money is received.
How Much Money Can You Borrow With a Private Student Loan?
Lenders may allow students to borrow up to 100% of their total cost of attendance minus any financial aid, but how much a student can borrow will depend on their qualifications. Generally, lenders will look at an applicant’s credit score, their major and the credit score of their co-signer, if there is one. If a co-signer or the borrower has good credit, some lenders may let an applicant borrow up to the full cost of their education.
However, borrowing the maximum loan amount can come with repercussions. Typically, the average private student loan interest rates range between 6% and 7%, with the maximum being 12.99% among major private lenders. In general, private student loan interest rates are higher than federal student loan rates, which average 5.8%. This means higher monthly payments.
For this reason, private student loans should only be an option after an applicant has exhausted funds from all other sources, such as federal student loans, scholarships, or grants.
Private student loans can be used to cover a student’s cost of attendance (CoA). This typically includes any costs involved with receiving education, such as tuition and miscellaneous fees, living expenses, transportation costs, books and other expenses. To maximize your loan and budget for your expenses, it’s best to figure out how much you need to borrow for the entire school year.
Eligibility Requirements for a Private Student Loan
Private student loans often come with strict requirements as lenders want to ensure the borrower can repay. Lenders typically assess the following factors to determine if you qualify for a private student loan.
Credit scores help determine eligibility for private student loans, and also influence interest rates and terms. You're more likely to be approved for private student loans when you have good credit and a track record of managing debt. In general, better credit scores can mean more favorable rates and terms. However, if you are an undergraduate, you will typically need a co-signer to qualify for better rates.
Lenders also consider your income in relation to your debt. If your debt-to-income (DTI) ratio is low, you might be eligible for a better rate. On the other hand, it will be harder to be approved with a high ratio, and even if you are approved, your rates will probably be higher. Typically, lenders require a DTI lower than 50%.
Most private student loan lenders require applicants to have a high school diploma or GED and be at least 18 years old. Most lenders also require borrowers to be citizens of the United States, although some specialize in student loans for non-citizens. International students must have a co-signer who is a U.S. citizen or permanent resident.
Student loan providers typically require borrowers to be enrolled at least half-time in a program of two years, four years or in a trade school. However, some lenders may reject loans for community colleges or non-four-year programs, so it’s best to contact them directly to determine if your academic plans are eligible.
List of Necessary Information
When applying for a private student loan, lenders will require the following information:
- Credit score and history
- Valid photo ID (e.g., driver’s license or another state-issued identification card)
- Social Security number
- Permanent or temporary school address
- School information and enrollment status
- Employment information (if applicable)
- Recent tax documents (if applicable)
- Financial information (income, monthly mortgage, rent payments, child support, etc.)
How To Apply for a Private Student Loan
Applying for a private student loan can be done directly through a lender’s website. Typically, this should be done once a student has decided on a school and knows how much they need to borrow after scholarships, grants and other forms of financial aid.
Shop around for the best lenders
Not all lenders will offer you the same rate or terms. Make sure to compare lenders and their rates, requirements, loan amounts, repayment terms, eligibility requirements and more.
Evaluate your eligibility
Some lenders will have stricter requirements than others, so it’s best to ensure you can meet said requirements before adding them to your list of options. For instance, some lenders will not require a credit score but may have higher interest rates.
Prequalify if possible
Some lenders will allow you to prequalify for a loan to find out what interest rates and terms you might qualify for. You can use this step to determine whether you need a co-signer.
Provide necessary documentation
Once you’ve decided on a lender, prepare your documents. The required documents will vary by lender, but preparing documents such as your valid ID, enrollment status, employment information and Social Security number can make the process easier.
Apply and wait for approval
Submit your filled-out application and wait for the approval. Once you get it, review the terms and conditions. This includes looking at the repayment options and any other disclosure information you should be aware of. Once you’re confident, accept the loan and verify the disbursement of funds.
When looking for a lender, consider the following tips:
- Review degree-specific financing products: Some lenders may offer financing specific to a degree, like undergraduate, business, medical or law school loans. These products may offer repayment terms more agreeable to your school schedule.
- Look at the interest rate: How much interest you pay and whether it's fixed or variable will affect how quickly your balance grows and how much you'll pay overall.
- Examine the fees: Fees can quickly add up and cause you to pay more than planned. Keep an eye out for application, origination and late fees.
- Take a look at repayment terms: Lenders allow students to choose from different repayment plans, such as immediate, interest-only or full deferment payments. Interest-only payments allow you to pay only for interest while in school, while full deferment postpones payments entirely until after your education.
- Check out other features: Some lenders offer other benefits or features to lower the cost of borrowing or add convenience. Look for lenders that offer autopay discounts, hardship programs, or the option to release your co-signer.
Pros and Cons of Private Student Loans
As with any financial decision, some advantages and disadvantages come with private student loans. Understanding them can help you decide if this is the best option for you.
Advantages of Using a Private Student Loan
- It has higher borrowing limits: If your cost of education is high or you do not have many grants or scholarships, private student loans can step in. As most lenders let you borrow up to the total cost of attendance, you can get more flexibility to borrow higher amounts as needed.
- It has fixed or variable interest rate options: Lenders offer you a choice between fixed or variable rates, which can help you plan for future payments.
- It can be advantageous for borrowers with good credit scores: Lenders are more likely to offer you a better deal if you or a co-signer has good credit. This means lower interest rates or fewer origination fees.
Disadvantages of Using a Private Student Loan
- It can be challenging to qualify: Undergraduate students typically do not have the necessary credit scores to benefit from a private student loan, making it harder to obtain.
- It offers fewer opportunities for loan forgiveness: Federal student loans offer forgiveness programs, which can help low-income borrowers. Some loan forgiveness programs include Public Service Loan Forgiveness (PSLF), IDR forgiveness and Teacher Loan Forgiveness.
- It has less flexibility for deferment or forbearance: While private lenders offer options for forbearance if you lose a job or encounter financial hardship of up to one year, federal forbearance can last up to three years. This lack of flexibility can be difficult to manage during difficult economic times.
- It often has higher rates than federal loans: If your credit is not good, private student loans may come with higher interest rates. Compared to federal loans where the interest rate is the same for every student, this can be an added stressor once you make repayments.
- It has less flexible repayment options: Unlike federal student loans, private student loans do not come with flexible repayment plans. Federal loans have an income-based repayment (IBR) plan and a Revised Pay As You Earn Repayment (REPAYE) option, both of which recalculate your payments based on your income.
Frequently Asked Questions About Private Student Loans
Private student loans can be advantageous for the right borrower, but understanding more about them is essential to decide if they’re best for you. Review the most frequently asked questions about private student loans below.
- Education Data Initiative. "Average Cost of College & Tuition." Accessed June 10, 2022.
- Education Data Initiative. "Average Student Loan Interest Rate in 2022." Accessed June 11, 2022.
- Federal Student Aid. "What is Loan Consolidation?." Accessed June 13, 2022.
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