Private Education Loans
Private Education Loans, also known as Alternative Education Loans, help bridge the gap between the actual cost of your education and the limited amount the government allows you to borrow in its programs. Private loans are offered by private lenders and there are no federal forms to complete. Eligibility for private student loans often depends on your credit score.
Some families turn to private education loans when the federal loans don't provide enough money or when they need more flexible repayment options. For example, a parent might want to defer repayment until the student graduates, an option that is not available from the government parent loan program. (Many PLUS loan providers are starting to allow parents to defer payments on the PLUS loan while the student is in school using an administrative forbearance. Interest continues to accrue, however.)
Private student loans typically have variable interest rates, with the interest rate pegged to an index, such as LIBOR or PRIME, plus a margin. The LIBOR index is the London Interbank Offered Rate and represents what it costs a lender to borrow money. The Prime Lending Rate is the interest rate lenders offer to their most creditworthy customers. A rate of LIBOR + 2.8% is roughly the same as PRIME + 0.0%. The spread between LIBOR and PRIME has been growing over time. So all else being equal, it is better to have an interest rate pegged to the LIBOR index, as such a rate will increase more slowly than a rate pegged to the PRIME index.
The interest rates and fees you pay on a private student loan are based on your credit score and the credit score of your cosigner, if any. Generally, if your credit score is less than 650 (FICO), you are unlikely to be approved for a private student loan. An increase of just 30 to 50 points in your credit score is often enough to get you better terms on your loan.
It is better to apply for a private student loan with a cosigner even if you could qualify for the loan on your own. Just applying with a cosigner usually results in a slightly lower rate, as such loans are not as risky for the lender. Moreover, the interest rates and fees are usually based on the higher of the two credit scores. So if your cosigner has a much better credit score than you, it could result in a much lower interest rate.
Private student loans may be used to pay for the EFC, the family's portion of college costs. While some lenders may offer private student loans in excess of the cost of attendance, any amount exceeding the difference between cost of attendance and financial aid is considered a resource. Like an outside scholarship, this will reduce need-based aid. (Some lenders offer non-school-certified private student loans to bypass this limitation by not informing the college about the loan. If the college becomes aware of the loan, federal regulations require the college to reduce need-based aid. Pending federal legislation would require lenders to tell colleges about all private student loans, eliminating this loophole.) This cost-of-attendance limitation only applies to education loans, which are loans that make enrollment in college a condition of the loan. It does not matter where the loan proceeds are sent (e.g., direct to the borrower vs to the school) or how the loans are marketed. On the other hand, mixed-use loans, such as home equity loans and credit cards, are not considered education loans and as such are not limited by cost-of-attendance.
Lenders provide different types of private education loans depending on the student's level of study.
Parents who are considering an alternative education loan often also consider a home equity loan or a PLUS loan. There are several tradeoffs between these options.
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