Skip to main content

Private College Loan Perils

Learn the downfalls of applying for and paying private loans when it comes to college loans.

In this article, you will find:

Page 1
Page 2
Page 3

Page 2

Use federal loans first. Families should not consider private loans, which are also called alternative loans, unless they have maxed out the federal loans, which offer better terms and more flexible repayment options. Federally guaranteed loans provide fixed rates, and everybody -- regardless of their FICO credit scores -- receives the same fixed interest rates.

The subsidized and unsubsidized federal Stafford loans are better alternatives for student borrowers and the PLUS loan is best for parents. If you meet the income qualifications, the federal Perkins Loan is the cheapest.

Many families, however, are routinely snubbing federal assistance. According to the Institute for Higher Education Policy, an astounding 20% of dependent students who have private loans never took advantage of federal loans. Another 19% of borrowers never maxed out their federal loans before embracing the private alternative.

Sadly, there are not enough schools like Barnard that are educating parents about the perils of private loans. Some might assume that Barnard can conduct its education effort because it's small, but Colorado State University has proven that even major institutions can spread the word. At Colorado State, about 20% of applicants for private loans either fail to exhaust their federal loan eligibility or skip filing the FAFSA, which is a requirement for obtaining federal loans. Staffers in the financial aid office at Colorado State call every family that falls into one of these two categories and explain their options.

Cosign the loan. Because a borrower's credit record is so important for private loans, students are at a disadvantage when they apply solo. With little or no history of using credit wisely, they can easily get stiffed with mediocre loans that pass along higher interest rates and fees. A parent who has good credit can avoid this problem by taking out the loan themselves or by cosigning the loan. Most lenders will consider only the highest credit scores among co-borrowers. What's more, the interest rate formulas for cosigned loans are slightly better than those on noncosigned loans for the same credit score.

Don't get tricked by slick marketers. If you've got a teenager who will head off to college soon, lenders are probably stuffing your mailbox with junk mail that makes obtaining a private loan seem as easy as ordering Chinese takeout.

Here's an excerpt from a letter sent by Sallie Mae, the big gorilla in the student lending industry, that I received a couple of months before my daughter began college: "Classes will start again before you know it. Don't let worrying about college expenses ruin your summer…Applying is fast, free and easy. Borrow up to $40,000 a year."

Sallie Mae went on to promise that my husband and I wouldn't have to worry about filling out any federal financial aid forms! Many parents might think that is a plus, but the lender was recklessly providing families with a way to jeopardize their chances for the best financial aid. Parents should fill out the federal form -- FAFSA -- because without doing so, they can't obtain federal loans, which are far preferable.

All the junk mail I received from lenders made private loans seem like the best approach by offering, in the words of one lender, "fast" credit decisions, "quick" renewals, and "easy" online applications. If you haven't been bombarded with these promotions, your child could be getting inundated by Internet pop-up ads touting these loans.

The promises sound great, but the price you pay will be high.

Don't be fooled by branded loans. When students receive their financial aid packages, sometimes they will contain loans that bear the name of the school. Beware of private loans masquerading as school loans that are nothing more than marketing ploys. Students may assume that the school branded loans are more favorable, but these loans typically are just like any other private loan, and in some cases they could be worse.

Join the Family

Your partner in parenting from baby name inspiration to college planning.

Subscribe