Banks and other financial institutions make private student loans without any direct financial backing from the federal government. Private loans are also known as private-label or alternative loans.
Federal loans, whether through a bank/private lender or the Department of Education, are funded and regulated by the federal government. Private loans are not subsidized by the government, and therefore are not regulated as closely. Borrowers should generally maximize their federal loan options before resorting to private loans.
The private student loan industry grew throughout the 1990s and early 2000s. Unfortunately, many of the lenders targeted low-income borrowers with subprime loans. Too many of these risky, high-cost loans were destined to fail and did fail at astronomical rates, especially after the economic crisis. Many lenders targeted for-profit school and low-income students with the most expensive products. The market is smaller now and generally geared more toward prime borrowers, but there is no guarantee that this situation will persist or that any individual private loan product is a good deal.
Private loan terms and conditions, including interest rates and fees, are generally based on your credit history or a co-signer’s credit history. Like government loans, most 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. The CFPB has sample letters to help you request that the lender release a co-signer from an account. Many lenders advertise that a co-signer may be released after a certain number of payments or other requirements, but do not let you know when you are eligible.
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, deferment and forbearance options that are available for federal loans. However, some private lenders may choose to offer cancellations or other relief in certain circumstances. You should check with your lender and ask about these options. Some private student lenders also offer deferments and forbearances, but these vary by program. 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.
Most private student loans will have a disclosure statement similar to the information that is included on mortgage loans and car loans. This is because most private loans are covered by the Truth in Lending Act while federal loans are not. Sample disclosures from the Federal Reserve Board:
Private Consolidation Loans
Borrowers cannot consolidate private student loans with the federal consolidation loan programs. However, if you have private loans, you may want to think about consolidating these loans into a new private consolidation loan. This may be a good idea if you want a single monthly payment. You may also be able to get a better deal if, for example, your credit score is better now than it was when you first took out the private loans.
It is very dangerous to consolidate federal loans into a private consolidation loan. You will lose your rights under the federal loan programs once you choose to consolidate with a private lender. These include deferment, forbearance, cancellation, and affordable repayment rights. Also, federal consolidation loans generally have lower interest rates.