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Private Loans are provided by lending institutions and are not in any way related to the loan programs offered by the Federal Department of Education. Private loans offer a funding alternative for students and parents. While using a private lender is an option, it is in the students’ best interests to apply for Federal, State, and Institutional Aid before considering this option. The benefits of applying for Federal Direct Student Loans over a Private/Alternative loan include lower interest rates and greater repayment options.
As a general rule, students should only consider obtaining a private education loan if they have maxed out the Federal Stafford Loan. Undergraduate students should also compare costs with the Federal plus Loan, as the Parent plus loan is usually much less expensive and has better repayment terms for their parent(s). The same principle applies to Graduate students. They should borrow in the Graduate plus Loan program before considering a Private Loan.
The fees charged by some lenders can significantly increase the cost of the loan. A loan with a relatively low interest rate but high fees can ultimately cost more than a loan with a somewhat higher interest rate and no fees (The lenders that do not charge fees often roll the difference into the interest rate.). A good rule of thumb is that 3% to 4% in fees is about the same as a 1% higher interest rate.
Be wary of comparing loans with different repayment terms according to APR, as a longer loan term reduces the APR despite increasing the total amount of interest paid. FinAid's Loan Discount Analyzer may be used to generate an apples-to-apples comparison of different loan programs.
The best private student loans will have interest rates of Libor + 2.0% or Prime - 0.50% with no fees. Such loans will be competitive with the Federal Plus Loan. Unfortunately, these rates often will be available only to borrowers with great credit who also have a creditworthy cosigner. It is unclear how many borrowers qualify for the best rates, although the top credit tier typically encompasses about 20% of borrowers.
Generally, borrowers should prefer loans that are pegged to the Libor index over loans that are pegged to the Prime Lending Rate, all else being equal, as the spread between the Prime Lending Rate and LIBOR has been increasing over time. Over the long term a loan with interest rates based on Libor will be less expensive than a loan based on the Prime Lending Rate. About half of lenders peg their private student loans to the libor index and about 2/5 to the Prime lending rate.
Some lenders use the Libor rate because it reflects their cost of capital. Other lenders use the Prime Lending Rate because Prime + 0.0% sounds better to consumers than Libor + 2.80% even when the rates are the same.
It is not uncommon for lenders to advertise a lower rate for the in-school and grace period, with a higher rate in effect when the loan enters repayment.
As a service, we provide access to Elm Select, which provides a list of lenders that offer private loans and the terms under which they make loans to students. To learn more about private loans go to finaid.org.