As the cost of college rises rapidly, and federal loan limits fail to keep pace, the private loan business has grown quickly. These loans are used to fill the gap between available federal aid, and what students and families can afford to pay out-of-pocket for college costs. However, these loans lack the more affordable, fixed rates, and flexible repayment options that federal loans have. Prospective borrowers should exhaust all federal grant and loan options (including PLUS loans) before considering a private student loan.

Banks and other financial institutions make private student loans without any financial backing from the federal government. Interest accrues on all private loans from the time they are disbursed, although interest costs can sometimes be deferred and capitalized when repayment begins. There are many different types of private loans, each program with its own rules and requirements. Private loans are also called private-label or alternative loans, and are often provided by the same lenders that also provide federal FFEL loans. Because the government does not subsidize private student loans, the rates and terms are not regulated the way they are for federal loans, which makes private loans more risky and expensive.

Loan Rates, Fees, and Limits

Private loan terms and conditions, including interest rates and fees, are generally based on your credit history or a co-signer’s credit history. This means that low-income students or those with negative credit histories will likely receive more expensive loans. Like government loans, private loans are supposed to be used only to finance postsecondary education (including books, transportation, and room and board). Check your school’s estimated cost of attendance and consult with the financial aid office before deciding on a private loan amount.

Private lenders may pressure or even require you to get a co-signer. A co-signer is a relative, friend or someone else who agrees to be responsible for your debt. Co-signers must understand that they are responsible for paying back the debt just as if they had received the money.

There are very important differences between government loans and private loans. If you take out a private loan, you will not be eligible for the same types of discharge options available for federal loans. The same is true for deferment and forbearances. Read your loan contract very carefully to learn about your private loan’s particular terms, conditions, benefits, rates, fees, and penalties. Private lenders do have to honor any promises they make about terms and benefits.

For questions to ask when considering a private loan, see the Project on Student Debt website.