How Private Student Loans Work

Federal students loans offer standardized loan types, interest rates and terms to most borrowers. With private student loans, your options and interest rate will vary, though there are some laws that affect all private student loans. Your credit, and that of a co-signer if you have one, will also impact what types of loans you qualify for and the interest rate you’ll receive.

Loan Types

Lenders may offer different types of loans depending on the degree you’re pursuing. The loan type can affect the total possible loan amount, interest rate and repayment terms.

  • Community college or technical training: Some lenders offer loans to students who are pursuing a two-year degree, attending a nontraditional school or are going to a career-training program.
  • Undergraduate school loans: You can take out undergraduate school loans to pay for expenses while pursuing a bachelor’s degree. Undergraduate loans may have lower interest rates and higher loan limits than community college loans.
  • Graduate or professional school loans: Graduate school loans tend to have higher maximum loan amounts than undergraduate loans, reflecting the higher cost of attending school for a master’s degree or doctorate. Some lenders have special loan programs for businesslaw or medical school.
  • Parent loans: Parent loans are offered to parents of students. Some families have an informal agreement that the child will make loan payments after graduating, but with a parent loan, the legal responsibility to repay the loan falls on the parent.

Loan Terms

The loan term is the length of the loan’s repayment period, which could range from five to more than 20 years for private student loans. Typically, shorter loans have higher monthly payments, lower interest rates and lower total costs. Longer loans have lower monthly payments, but higher interest rates and higher total costs.

Loan Limits

Loan minimums: Most lenders have a minimum amount you can borrow. Although it could be as low as $1,000, a private student loan may not be the best option if you only need a few hundred dollars for books. Loan minimums may vary depending on your state of permanent residence.

Loan maximums: Lenders can have several limits that impact how much you can borrow. There could be a maximum annual or total amount you can borrow from that lender. Or, there could be a maximum aggregate private and student loan amount you must be under to qualify for a loan. The maximum loan limits may be higher if you’re going to graduate, professional or medical school, reflecting these programs’ potentially higher cost.

Regardless of the other limits, you also may be limited to borrowing up to your school’s certified cost of attendance minus the other financial aid you received.

Interest Rate Types

Lenders offer student loans with either a fixed or adjustable interest rate. You may not be able to switch your interest rate type after taking out a loan, so carefully consider your options before deciding.

When you’re comparing student loans from different lenders, you should look at the annual percentage rate rather than the interest rate. The APR is your total cost of borrowing each year, which takes into account the loan’s interest rate, how often your interest compounds, and other fees or discounts.

Fixed-rate loans: With a fixed-rate private student loan, your interest rate is set when you take out the loan and it won’t change over the life of the loan. The rate you lock in can depend on market rates, the lender, your credit and the loan’s terms.

“In general, a fixed-rate loan is a better long-term option for financing your education,” says Fleischman. “You are able to plan for future payments without worrying that interest rates may increase payments faster than your income increases.”

Variable-rate loans: The same factors that may determine your interest rate with a fixed-rate private student loan can impact your initial interest rate when you take out a variable-rate loan. However, with variable-rate loans, your interest rate may rise or fall in the future.

Variable-rate loans’ interest rates are tied to an index, such as the prime rate, 11th District Cost of Funds Index or the London Interbank Offered Rate. The lender adds a margin to the index to determine your total interest rate. There may be a limit to how high or low your interest rate can go.

Variable-rate student loans tend to have a lower initial interest rate than fixed-rate loans and could remain lower. However, you’re taking on risk because the loan’s interest rate could rise, causing your monthly payment and total cost of borrowing to increase.

A variable-rate loan may be best for those who can quickly repay the loan, which will limit your risk, or those who can afford higher monthly payments if the interest rate rises.

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