Why Many Borrowers Choose Private Student Loans
Why Many Borrowers Choose Private Student Loans

Of the nearly $1.5 trillion in outstanding student loan debt, about 90 percent of it is federally backed or guaranteed. The remaining 10 percent, which comes to about $150 billion, is issued by private lenders. These private student loans are the subject of much research and discussion in the financial community. Read any article on the various ways to finance a college education and you'll inevitably bump into a discussion comparing private student loans with their federal counterparts.

There are countless moving pieces to the puzzle of education finance, there's no question about it. But what, in short, are the pros and cons of this 10 percent piece of the educational lending pie? How do private student loans stack up against the other 90 percent of the market represented by federal student loans? Here's a basic summary of why many people often choose to use private lenders when borrowing money for college and graduate school, along with some of the pitfalls of private debt.

Rates Can Be Lower

Since private loans are based more on your credit score, those with a strong credit history can achieve lower rates. With government loans, rates are set by Congress and everybody pays the same exact rate. When you're talking about debt that will take several years to pay off, even a rate that is a half-point lower can make a huge difference in the total amount of money you pay back on the loan.

Rates are Often Variable

Many private loans feature fixed rates but it's also possible to get variable interest rates when you opt for a private lender. This can be either an advantage or disadvantage depending on how the economy performs. If the prime rate goes very low, students with government loans lose out because they're stuck with fixed rates. But in high interest environments, fixed rate loans can be better than variable loans for obvious reasons. It helps for students to know that private loan interest rates can be either fixed or variable.

Limits are Higher

Many students are surprised to find that government loans are capped and sometimes don't cover the entire cost of college or graduate school. This is often the time they first learn of private loans and turn to them as a gap-filler for their educational expenses. With private student loans, there are no set limits on the amount you can borrow. That means you'll never get stuck in the middle of senior year, or the final year of med school facing a funding crisis for your education.

A Co-signer Might be Necessary

One area where federal loans usually have a leg-up on private money is in the area of co-signers. Most government-backed student loans do not require anyone other than the student to sign the loan agreement. For personal student loans, some institutions, but not all, will ask for a co-signer if the student has no credit or an insufficient credit score.