Private Student Loan Myths
Surprisingly, many student loan borrowers have serious misconceptions about how private student loans work. Here are several myths about private student loans and the truths behind each one.
Myth: As long as you are in school, you will qualify for a private student loan.
Private student loan lenders are not connected directly to your college. They care about your credit history and want to make sure you can pay the required monthly payments. If you are an undergraduate and just heading to college you may have little to no credit history. This means you will not qualify for a private student loan without a cosigner. The Consumer Financial Protection Bureau (CFPB) reports that about 90% of lenders require undergraduate borrowers to obtain a cosigner.
Myth: You will borrow more than you should with a private student loan.
There is an element of truth to this myth. A student borrowing only Federal Direct Stafford loans is unlikely to have total student loan debt at graduation that exceeds his or her annual income. To have excessive debt, the student would have to have borrowed private student loans or have agreed to repay parent loans. But, how much you borrow is a matter of choice, not necessity. Nobody forces you to accept a private student loan or to borrow to the limit. You may qualify for a higher loan amount than you need. Do not take it. You should borrow only what you need.
Myth: Private student loans are never more favorable to federal student loans.
As with all myths there is some serious truth to this one. Private student loans are generally more expensive than federal student loans. However, that depends on the type of federal loan and whether you have excellent credit. The Federal Direct Stafford loan is almost always less expensive than private student loans. But, a private student loan or private parent loan may be less expensive than a Federal Direct PLUS loan, if the borrower has excellent credit. Still, the Federal Direct PLUS loan has superior repayment terms than most private loans.
Myth: Interest rates on private student loans are higher than other loans.
The interest rate for private student loans is determined by your credit history and that of the cosigner if you have one. Generally, the interest rates for Federal Direct Stafford loans are lower than the interest rates on Federal Direct PLUS loans. Private student loans may offer interest rates and fees that are competitive with the Federal Direct PLUS loan, if the borrower or cosigner has excellent credit. But, private student loans do not necessarily offer the same benefits as federal education loans, such as death and disability discharges and loan forgiveness.
Myth: The interest rates on private student loans are always variable, so you never know what your monthly payment will be.
Variable interest rates put you at the mercy of the market. The ups and downs of the interest rate will affect your monthly payment and your pay-off plan. Private student loan lenders offer variable interest rates, but many offer fixed interest rates as well. A fixed interest rate will ensure you have a stable monthly payment for the term of the loan.
Myth: Shopping around for a lower interest rate will hurt your credit score.
According to Fair Isaac Corporation, the company behind the FICO credit score, applications for multiple private student loans within a short period of time (e.g., within 30 days) are treated as though they were a single inquiry. Even if an application is not coded to reflect shopping-around behavior, it will ding your credit score by only a few points.
Myth: You don’t have payment options with private student loans.
Sometimes you or your family will encounter a hardship, making repayment of your student loan more difficult. Private student loan lenders offer repayment options for these scenarios, although the options are more limited than those available for federal student loans. These options include forbearances and partial forbearances (periods of interest-only payments), as well as extended repayment plans and graduated repayment plans. It is important to note that these options may exist, but not with all private lenders.
Myth: Refinancing student loans will save you money.
Refinancing a private student loan does not always save the borrower money. To save money, the interest rate on a private consolidation loan must be lower than the interest rate on each loan that is refinanced. If the borrower is required to pay a fee on the refinanced loan, the fee must be considered as part of the comparison. If the new loan has a longer repayment term, the total cost of the refinanced loan may be higher, since interest will be charged over a longer period of time. Sometimes, a private consolidation loan saves money only because of a shorter repayment term and not because of lower interest rates. It may also be worthwhile to refinance only the loans that have higher interest rates than the private consolidation loan. Otherwise, the borrower may save more money by accelerating repayment of the loans with the highest interest rates.
Myth: Your cosigner will be stuck repaying your student loan if you die.
About half of private student loans offer a death discharge similar to the ones available on federal student loans. Even lenders that do not provide an automatic death discharge still have a compassionate review process, and may forgive loans when the borrower was killed in action while serving on active duty in the U.S. Armed Forces or as a first responder. The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (P.L. 115-174) requires lenders of new private student loans made in 2019 or later to release cosigners upon the death of the student borrower.
Myth: Your private student loan cosigner is stuck until the loan is paid off.
Many lenders offer cosigner release as an incentive for bringing on a cosigner with your private student loan. You can apply for cosigner release after a specified number of payments and if you satisfy the lender’s credit criteria. Keep in mind, however, that borrowers consistently report challenges when trying to qualify for cosigner release. Less than 1% of borrowers qualify for cosigner release.
Myth: Private student loans are eligible for Public Student Loan Forgiveness.
More than two-thirds of student loan borrowers believe that private student loans can be eligible for Public Student Loan Forgiveness (PSLF), sometimes incorrectly referred to as Obama Student Loan Forgiveness. Very few borrowers who applied for PSLF have actually qualified for the loan forgiveness program. In general, and for PSLF in particular, government-sponsored loan forgiveness programs are available only for federal student loans. Private student loans are not eligible for PSLF.
Myth: You will have to pay a fee if you pay off your private student loan early.
There are no prepayment penalties on private student loans. The Higher Education Opportunity Act of 2008 [P.L. 110-315] amended the Truth in Lending Act to prohibit private student loans from imposing “a fee or penalty on a borrower for early repayment or prepayment of any private education loan” [15 USC 1650(e)]. This means that private lenders cannot charge any extra fees when a borrower makes extra payments on their private student loans or pays off their private student loans in full. (Federal student loans have never had prepayment penalties.)
Myth: If you pause payments by obtaining a deferment or forbearance on your private student loans, interest will not accrue on your private student loans.
Some private student loan lenders offer programs like forbearance to pause payments due to financial crisis or family hardship. This does not mean that interest stops too. The interest will continue to accrue and if you do not pay it, it will be capitalized when you exit the forbearance period. Interest continues to accrue even when you aren’t making payments on your student loans.