Why Do Some Students Borrow Private Student Loans?

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Nick Mann

By Nick Mann

March 27, 2019

The majority of student loans are federal. Federal student loans are a popular option because they offer low fixed interest rates, flexible repayment, no credit check (except for PLUS loans) and loan forgiveness.

Nonetheless, some students choose to borrow private student loans. About 5.5 percent of undergraduate students borrow private student loans, according to data from the 2015-2016 National Postsecondary Student Aid Study (NPSAS).

Here are some reasons why.

Access to More Money

College can be expensive, and federal student loans don’t always cover all of the costs.

The annual loan limits are $5,500 to $7,500 for dependent undergraduate students and $9,500 to $12,500 for independent undergraduate students, depending on the year in school.

The aggregate loan limits are $31,000 for dependent undergraduate students and $57,500 for independent undergraduate students.

Dependent undergraduate students whose parents are denied a Federal Parent PLUS loan are eligible for the higher loan limits available to independent students.

Some students simply need more than that. For instance, they may be attending an expensive private college where a federal student loan by itself is not sufficient. Of undergraduate students who borrow private student loans, more than a third (35.4%) had reached the Federal Direct Stafford loan limits.  

Private student loans often allow students to borrow up to 100 percent of the Cost of Attendance (COA). This provides them with access to more money than with a federal student loan.

Needing to borrow private or parent loans may be a sign of over-borrowing, where the student is borrowing more money than they can reasonably afford to repay.

A High Expected Family Contribution

Financial aid is based on financial need, the difference between the college’s cost of attendance and the expected family contribution (EFC).

The EFC is calculated after the student submits the Free Application for Federal Student Aid (FAFSA).

A high EFC will reduce the student’s demonstrated financial need, limiting the amount of financial aid available to the student.

The EFC is a harsh assessment of the family’s ability to pay for college.

In some cases, their parents may not be able to meet their EFC, especially if they are putting multiple children through college at the same time. In other cases, the college leaves the family with unmet need.

This creates a financial gap that may require additional borrowing to pay for college costs. Borrowing a private student loan can help fill that gap.

Excellent Credit Potentially Qualifies for Lower Interest

Eligibility for federal student loans does not depend on the borrower’s credit history. Everyone pays the same interest rate regardless of their credit score.

That helps borrowers with less than ideal credit. But, it can also be a drawback for borrowers with excellent credit.

Private student loans are credit-based, meaning most require a credit check. This enables lenders to determine which borrowers have great credit. Those who do may qualify for a lower interest rate.

If a parent agrees to cosign, which is usually required with private student loans, it could result in a lower interest rate because the interest rate is based on the parent’s credit score if it is better than the student’s credit score.

Private student loans are unlikely to offer a lower fixed rate than a Federal Direct Stafford loan. But, if the borrower or cosigner has excellent credit, the interest rate on a private student may be lower than the interest rate on a Federal Parent PLUS loan.

The Choice between Fixed and Variable Interest Rates

Federal student loans have fixed interest rates. Private student loans, however, typically offer borrowers a choice between fixed and variable interest rates. Some even allow borrowers to switch between the two without incurring additional fees.

While fixed interest rates are the best bet for many borrowers, this isn’t the case for everyone. Some can save money if they get their timing right and opt for a variable interest rate.

Variable rates tend to start out lower than fixed rates. If they don’t rise by much, it can be a better deal than fixed rates.  

If the borrower will pay off a variable-rate private student loan before the interest rates rise too much, they might be able to save some money on interest as compared with a fixed-rate federal student loan.

Parents Don’t Want to Be the Primary Borrower

With Federal Parent PLUS loans and private parent loans, the parent is the only borrower. This gives the parent more control over the debt, ensuring that payments are made on time. But, the student is not obligated to repay these loans.

Some parents prefer private student loans because the student is considered the primary borrower. Unlike a parent loan, the student is also responsible for repaying the debt. The student loan bills are sent to the student.

Of course, the parent is still responsible for repaying a private student loan if they cosign the loan. Late payments on a cosigned loan will affect the cosigner’s credit, not just the student’s credit.

Despite these risks, some parents find the idea that the student is obligated to repay the debt to be appealing.

Student May Be Ineligible for Federal Student Loans

Some students may be ineligible for federal student loans. This can occur when a student gets bad grades (e.g., less than a 2.0 GPA on a 4.0 scale) and is no longer maintaining satisfactory academic progress. It can also occur when a student is enrolled less than half time.

Other reasons a student might not qualify for federal student loans include failing to register with Selective Service before reaching age 26. Students who are not U.S. citizens, permanent residents or eligible non-citizens are ineligible for all federal student aid, including federal student loans.

If a student loses eligibility for federal student loans, even on a temporary basis, they may have no choice but to borrow private student loans.

A good place to start:

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