Most college students receive financial aid that covers at least some of their education expenses. According to the National Center for Education Statistics, 87% of first-time, full-time undergraduate students were awarded aid through loans or grants.
Despite financial aid availability, you may find that your aid package doesn’t cover your school’s total cost of attendance. If you need additional funds and are scrambling to come up with the cash, private student loans can play an important role in financing your education — as long as you’re aware of their possible drawbacks.
What are private student loans?
The U.S. Department of Education is the biggest issuer of college loans. In fact, the Consumer Financial Protection Bureau reported that the federal government makes up 92.7% of the total outstanding student loan debt; just 7.3% is from private student loans.
Private student loans can come from banks, credit unions, and specialty lenders. Unlike federal loans for undergraduate students — which don’t require credit checks and don’t have minimum credit requirements — private lenders have stricter requirements.
You typically have to meet a certain credit score and income minimum to qualify for a private student loan or have a co-signer — a friend or relative with a solid credit history — apply for a loan with you.
5 scenarios where private student loans make sense
Depending on your credit, you may qualify for private student loans with lower interest rates than you’d get with federal loans. But private loans don’t have the same benefits as federal loans, so private loan borrowers aren’t eligible for programs like Public Service Loan Forgiveness (PSLF) or income-driven repayment (IDR) plans.
That said, there are some instances where private student loans can be a good idea:
1. You reached the annual or aggregate borrowing limits
While federal loans are an excellent place to start when you need to borrow money to pay for college, the federal government limits how much you can borrow as an undergraduate or graduate student.
For example, the annual maximum for first-year undergraduate students is $9,500. And the aggregate maximum is $57,500.
With rising tuition costs, you could quickly exceed that amount. To cover the remainder and complete your degree, you can use private student loans as a solution.
2. Your program isn’t eligible for federal aid
To get federal financial aid, including federal loans, you must be enrolled at a qualifying school in an eligible degree or certificate program. Not all schools or programs are eligible. For example, you can’t use federal student loans for most coding boot camps.
Private loans are an alternative financing option if your program doesn’t participate in the federal Direct loan program.
Use the Federal School Code Search tool to determine if your school and program qualify for federal loans.
3. You have outstanding credit (or a co-signer)
If you have very good to excellent credit — that means a score between 740 and 850 — and a reliable source of income, you may qualify for private student loans with lower rates and fees than you’d get from the federal government.
Interest rates on federal loans are higher than they’ve been in years. For example, the Parent and Grad PLUS loan rate is currently 7.54%. And those loans have a high disbursement fee of 4.228%.
By contrast, many private student loans are available without disbursement or origination fees and may offer lower rates. As of December 2022, variable-rate loans are as low as 3.25%, and fixed-rate loans are as low as 3.99%.
Many college students have less-than-stellar credit scores and lack a steady source of income. However, you may qualify for a low-interest loan if you have a co-signer on your loan application.
4. You’re an international student
Federal financial aid, including federal loans, is only available to U.S. citizens and eligible noncitizens. Other students aren’t eligible.
Many private student loan lenders require borrowers to be U.S. citizens or have a co-signer who is a citizen. But some lenders, such as Ascent Funding and MPOWER Financing, have loans specifically designed for international students.
5. You don’t plan on using federal benefits
Federal student loans have substantial benefits, including the ability to enter into an IDR plan and the potential for PSLF. However, not everyone will utilize those benefits. In some cases, they may not be necessary. For example:
- You don’t plan on working for a nonprofit organization or government agency, so you wouldn’t be eligible for PSLF.
- You’re entering a high-paying field, such as engineering or computer science, and will be able to afford your payments comfortably.
- Your skillset is in high demand, so you aren’t worried about periods of unemployment and won’t need to take advantage of federal forbearance or deferment programs.
In those scenarios, private loans may be a good choice and give you a lower interest rate than you’d get with federal loans. Remember that life is full of curveballs, and your career and life plans could change.
Paying for college
When it comes to paying for college, scholarships, grants, and federal loans are the recommended starting points. Private student loans can supplement your other financing options, but they offer fewer benefits than federal loans, and you’ll need a strong credit history or a co-signer to qualify. For most borrowers, private student loans are best used to fill gaps in financial aid packages rather than makeup the most of your financing.
For borrowers in some exceptional circumstances, such as those enrolled in programs that aren’t eligible for federal aid, private student loans may be one of the only ways to finance your education. If that’s the case, compare quotes from multiple lenders to get the best rates, and remember that you can refinance your student loans later to lower your interest rate and save money.