How Do Private Student Loans Work?

You can take our private loans to help pay for your own or your child’s education, but they should be a last resort.

Written by Zina Kumok / February 24, 2022
Reviewed by Mark Kantrowitz

Quick Bites

  • Private student loans can fill the gaps where federal loans fall short.
  • Only take out the bare minimum you need in private loans.
  • Private loans offer far fewer loan repayment and loan forgiveness options.
  • Private student loans usually have higher fixed interest rates.

Paying for a college education isn’t always a straightforward process. While some students can rely entirely on one type of funding, like federal student loans or a full-ride scholarship, many have to look for supplementary options—especially when pursuing a more expensive degree.

When you’ve already maxed out your federal student loans and other forms of financial aid, private student loans are the next avenue to consider. Here’s what you should understand about how they work.

Inside this article

  1. What is a private student loan?
  2. Private vs. federal loans
  3. Refinancing and consolidating

What is a private student loan?

A private student loan is used to pay for educational expenses like tuition, room and board, and books. Unlike federal student loans, private student loans are not funded by the federal government. To take out a private student loan, you have to apply with a third-party lender like College Ave, CommonBond, Discover, Earnest, Laurel Road, PNC Bank, Sallie Mae and SoFi.

The annual loan limit with a private student loan usually ranges from $1,000 to the annual cost of attendance, minus any other financial aid. The aggregate total loan limit is usually between $120,000 and $150,000 for undergraduate students and between $350,000 and $500,000 for graduate and professional students.[1]

Repayment terms for private student loans depend on the lender, usually ranging from five to 20 years. Unlike federal student loans, private student loans can have variable or fixed interest rates. Federal loans only offer fixed interest rates.

A variable rate loan will have an interest rate that may change as interest rates change. If overall interest rates increase, then the variable rate on the private student loan will increase. Fixed-rate loans will have the same interest rate throughout the entire loan term.

Interest rates depend on your credit score (and the credit score of your cosigner), how much you’re borrowing, the repayment term, if you have a cosigner, your academic major and the type of degree. Shorter repayment terms usually have lower fixed interest rates with higher monthly payments, while longer repayment terms have higher fixed interest rates and lower monthly payments.

How private loans differ from federal loans

While you can use federal and private student loans to pay for the same expenses, the two loan types differ in important ways.

Private student loans almost always require a cosigner, an adult who agrees to take on the financial responsibility if you default on the loan. If you stop making payments, the lender can go after the cosigner for the remaining balance.

While federal loans are backed by the government, private loans are not. That’s why they almost always require a cosigner as a form of security. Even if you default, they’ll have someone else to pursue for the remaining loan balance.

Private student loans also do not offer as many repayment options as federal loans, like income-driven repayment (IDR). IDR plans let struggling borrowers reduce their payments, but private loans don’t provide that kind of flexibility.

Tip: If you have a private student loan, the only way to reduce your payment is to refinance to a longer repayment term.

Federal loans offer a variety of loan forgiveness programs, where borrowers can work for a certain number of years for a specific employer or in a specific occupation to have the remaining balance forgiven. Private loans do not offer loan forgiveness plans. If you take out a private student loan, you’ll have to repay all of it, plus interest.

“Private student loans should be seen as a student’s last resort,” says Jay Fleischman, student loan lawyer at Money Wise Law. “Limited repayment flexibility makes private educational debt difficult to justify in all but the most extreme of circumstances and only after consulting with an independent financial professional.”

Applying for a private student loan vastly differs from applying for a federal student loan. Private student loans have credit score and income requirements, while federal loans do not. If you don’t meet those criteria and don’t have a cosigner, you’ll find it almost impossible to qualify for a private loan. Federal student loans don’t have an income or credit threshold, so any eligible borrower who applies will qualify.

Private student loans also have more limited forbearance options than federal loans. Borrowers with federal loans can often defer their loans for up to a year at a time for three years in total. With private student loans, the maximum forbearance period depends on the lender, but is usually much shorter than for federal student loans, typically a year in total duration.

The general rule of thumb is to always max out your federal student loans before taking out a private student loan. If you end up using a private loan, compare lenders, interest rates and other terms before signing up.

Refinancing and consolidating private student loans

If you have multiple private student loans, you can combine them into one loan when you refinance. Refinancing can simplify repayment, making it easier to stay on top of your loans.

Private student loans are usually made on the strength of the cosigner’s credit, not the student’s. There is tiering of the interest rates based on the higher of the credit scores of the borrower and cosigner.

The interest rate starts off lower during the first year, and subsequent years have a higher interest rate due to decreases in credit scores. By the time someone graduates, credit scores are at their lowest and interest rates are at their highest.

After graduation, it takes a few years of paying all debts on time for the borrower’s credit score to improve enough so they can qualify for a lower interest rate if they refinance. Lenders also want to see at least two years of employment with the borrower’s current employer.

When you become a more desirable borrower, lenders will likely be willing to provide lower interest rates.

Refinancing private student loans usually means finding a lower interest rate with a new lender. When you refinance private student loans, you can often save thousands or even tens of thousands of dollars in total interest.

Article Sources
  1. Elyssa Kirkham, “How Much Money Can I Take Out in Student Loans?” Student Loan Hero, March 25, 2021, https://studentloanhero.com/featured/how-much-student-loans-can-i-get.

About the Authors

Zina Kumok

Zina Kumok

Zina Kumok has written about student loans, financial literacy and other personal finance topics for sites like Bankrate, Forbes Advisor and Business Insider. She has also written for fintech companies like Mint, Chime and Ally.

Full bio
Mark Kantrowitz

Mark Kantrowitz

Mark Kantrowitz is a nationally-recognized expert on student financial aid, the FAFSA, scholarships, 529 plans and student loans. His mission is to deliver practical information, advice and tools to students and their families so they can make smarter, more informed decisions.

Full bio

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