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By Heidi Rivera
July 9, 2020
Rangely Garcia / Money

College is expensive. That’s hardly a surprise, but as tuition has climbed and incomes have stagnated, the average net price of a four-year public college has grown to 23% of a typical household income.

That’s why relatively few students can afford to go to college without financial aid — and why even after grants and federal student loans are used, some still have large gaps to fill. Each year, more than one million students seek private student loans as an alternative to bridge those gaps.

Private student loans have gotten a bad rap, and for good reason — they’re expensive and have strict, narrow repayment plans. But for some, it’s the only way to pay for college.

If going down the private loan route is the only way to get through college, follow these steps before you borrow.

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Crunch the Numbers

Borrowing for college can be a smart investment, if done responsibly. Recent data from the U.S. Bureau of Labor Statistics shows that those with a bachelor’s degree earned almost double on a weekly basis than those with just a high school diploma, and they also had a lower unemployment rate.

To borrow responsibly, you first have to calculate exactly how much you’ll owe in tuition, living expenses, books and other miscellaneous fees. “You never want to take more in loans than you actually need,” says Karen McCarthy, director of Policy Analysis at the National Association of Student Financial Aid Administrators (NASFAA). She also states that the same thing goes for borrowing less than you need, since you don’t want to find yourself in a tight spot in the middle of a semester.

If you’re just researching colleges, you can use each institution’s net price calculator to get an estimate of how much you’d have to borrow to attend.

But if you’re applying to colleges, you’ll want to make sure you fill out the Free Application for Federal Student Aid (FAFSA). The FAFSA is required to be considered for federal grants as well as many state scholarships, neither of which have to be paid back. By filling out the FAFSA you’ll also be able to see whether you’re eligible for direct subsidized or unsubsidized federal loans.

Colleges will use information from your FAFSA (and sometimes another form called the CSS Profile) to determine how much financial aid you’ll receive. Once you’re accepted, you’ll get an award letter, which outlines the cost of attendance, like tuition, fees, room and board, alongside any financial aid you’re eligible for.

It’s important to read those letters carefully, as they can be misleading or just difficult to decipher, and sometimes federal student loans and parent loans will already be included under the “aid” section.

Part of crunching the numbers is thinking about your exit strategy, or how you plan on repaying your debt. Start by comparing your field of study’s average starting salary against how much you’ll need to borrow to graduate.

“It’s not a foolproof method,” says McCarthy, but you can use a free online loan calculator, and see how much would be a reasonable monthly payment.

“Finally, to the extent that you’re able, try to keep your borrowing to a level that’s underneath that starting salary, so that you are not struggling to repay once you get out,” she adds.

Make Sure to Max Out Federal Aid

Nearly every financial aid expert will tell you to max out federal financial aid before you apply for a private student loan.

As previously mentioned, the FAFSA determines your eligibility for different types of federal and state-level aid, including federal student loans offered by the U.S. Department of Education. Unlike private loans, which require you to pass a credit check or apply with a co-signer, federal student loans can be accessed by almost any student who is a U.S. citizen and is in good academic standing.

The loans are automatically deferred while you’re in school, as long as you’re enrolled at least half-time, and they offer flexible repayment programs — something that’s out of question with a private student loan.

Federal loans also have fixed interest rates and, if they are subsidized, the Department of Education will take care of paying the interest while you’re in school. They have an annual limit of $5,500 to $12,500, depending on your school year and dependency status.

If you need more than that, you can explore Parent PLUS loans. Parent PLUS loans can be taken out for the full costs of attendance, and also offer fixed interest rates and no payments while the student is in school. But since the loan will be issued under the parent’s name, they must pass a simple credit check to get the loan.

However, there’s a silver lining if a parent can’t get approved. “If a parent does have some type of adverse credit history and they are denied, a student may be able to borrow additional funding,” McCarthy says.

“Sometimes that doesn’t work because it’s still not enough money for the student to be able to attend, but in some cases, it can be a real lifesaver for the student,” she adds. Although this amount is fixed, dependent students may get up to $5,000 more in federal loans.

Line Up a Co-signer

Unlike federal loans, which don’t require you to pass a credit check, private loans are based on the borrower’s creditworthiness.

To qualify for a private loan and get the lowest interest rates possible, you must have an excellent credit history and a steady source of income — something that’s practically impossible if you just graduated high school or are still studying full time. This is why over 90% of undergraduate private student loans are co-signed.

A co-signer doesn’t have to be a parent. It can be a relative, a family friend, or basically anyone you know that’s willing to lend you their credit, to increase your chances of approval. But there’s a catch: If someone agrees to co-sign your loan, they are equally responsible for your debt.

This means that if you can’t repay your loan once you graduate, or drop out of school, they will have to make up for the missed payments. Additionally, their credit score and ability to borrow could be impacted, so it’s important to keep this in mind when asking someone to be your co-signer.

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Check Out Multiple Lenders

Private student loans are not one-size-fits-all. Just because you know someone who applied with a certain lender and had a positive experience, or you received an offer in your inbox, that doesn’t mean it’s the right fit for you.

“You should compare the terms of the loan, interest rate, any loan fees, and what it costs you to borrow,” says McCarthy, to ensure you get the best deal possible.

For this step, McCarthy recommends contacting the school’s financial aid office and making an appointment with a counselor. Financial aid counselors usually have a list of lenders that work with students from that particular school, and can give you advice on lenders that can cater to your situation. They also have information on scholarships, grants and other aid programs you may have overlooked.

You can also use an online marketplace, such as Credible, to compare multiple loan offers you may qualify for, by filling out a single application.

When comparing loan offers, make sure to aim for lenders that offer pre-qualification. This will allow you to compare offers without affecting your credit.

Consider the “Real” Cost of the Loan

Interest rates for private student loans can be fixed or variable. Just like with federal loans, if you choose a private student loan with a fixed interest rate, it will remain the same throughout the life of the loan. However, fixed interest rates for private student loans currently range between 4% and 12%, depending on your credit, versus 2.75% for undergraduate federal loans in the upcoming school year.

Variable interest rates start lower, sometimes at 1.99%, but again, this will be based on your credit. Variable interest rates fluctuate according to the current market conditions, which may cause your rate to increase at any given time. Interest caps are also much higher than those of fixed rates, and could be as high as 15%, depending on the lender.

“With most private loans, the interest starts to accrue right away,” McCarthy says. While interest rates for both unsubsidized federal loans and private student loans accrue on a daily basis, McCarthy points out that because private student loans have higher interest rates than those of federal loans, the amount of interest that will be capitalized will be much higher. “In the end, that will increase the amount of money that you’re repaying,” she says.

When comparing lenders, look at the annual percentage rate (APR) of the loan instead of just looking at the interest rate. The APR of the loan is the figure that represents the true cost of borrowing. It includes the interest rate, in addition to any lender fees.

Ask About Repayment Terms and Benefits

With federal student loans, repayment usually begins six months after you graduate or drop below half-time enrollment, and there are four different types of repayment plans that can reduce your monthly bill.

Private student loans are more strict when it comes to the types of repayment they offer. “Some private loans have multiple repayment plans to choose from, and some just have one: The repayment term of 10 years. With this repayment, they just take the amount you borrow, distribute that over 10 years and say, ‘This is what you’re going to owe us every month, and you don’t have any options,’” says McCarthy.

Before you borrow, ask the lender about their repayment options, and if there are any grace periods, internship deferments, or special hardship programs in case you’re not able to secure a job right after you graduate.

Also, ask if they offer a co-signer release and what the requirements are to qualify. Consider any borrower benefits, like discounts for enrolling in automatic payments, and rewards for graduating from the same degree program you requested the funds for.

Gather All Your Info

It can take a lender a couple of weeks and up to a month to process your application and disburse the funds. To make sure that the process is as smooth as possible, gather all of the necessary information beforehand.

You’ll need your social security number, permanent address and date of birth, a form from the school that details how much you’ll need to cover all of the costs of attendance, and proof of income (if applicable), which can be in the form of pay stubs or bank statements.

You will also have to provide your school’s name and address, field of study, the academic term for which you’re requesting the loan (full year, one semester, trimester, etc.), and expected graduation date.

In some cases, you’ll be asked to provide two or three personal references that can vouch for your character. If you’re applying with a co-signer, you’ll also have to provide their personal details and signature, along with their financial information, and any supporting paperwork that can verify it.

Use Your Spare Cash Wisely

Most students don’t pay anything on their loans while in school, in part because they simply can’t afford it. But if you do get any extra money, McCarthy recommends using it to pay down interest.

When you have a private loan or a federal unsubsidized loan, the interest accrued will be capitalized once your grace period ends. This means that it will become part of the principal balance, and you will have to pay interest on that amount as well. But since private loans carry much higher interest rates than federal loans — especially now that interest rates for federal loans have fallen to record lows — you should prioritize paying those first, to make your debt more manageable once you graduate.

“Even if it’s not required that you pay it, it’s always in your best interest from a financial perspective to make those payments if you can,” says McCarthy. “If you don’t have those resources available, don’t sweat it. But if you do have the ability to do it, that will only benefit you.”

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Advertiser Disclosure

The purpose of this disclosure is to explain how we make money without charging you for our content.

Our mission is to help people at any stage of life make smart financial decisions through research, reporting, reviews, recommendations, and tools.

Earning your trust is essential to our success, and we believe transparency is critical to creating that trust. To that end, you should know that many or all of the companies featured here are partners who advertise with us.

Our content is free because our partners pay us a referral fee if you click on links or call any of the phone numbers on our site. If you choose to interact with the content on our site, we will likely receive compensation. If you don't, we will not be compensated. Ultimately the choice is yours.

Opinions are our own and our editors and staff writers are instructed to maintain editorial integrity, but compensation along with in-depth research will determine where, how, and in what order they appear on the page.

To find out more about our editorial process and how we make money, click here.

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