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Private Loans and Alternatives

A generation ago, the vast majority of students were able to fund their college educations through a combination of grants, scholarships, income from employment, and federal student loans. But times have changed, and as tuition rates have skyrocketed, federal grants and loans have failed to keep up with the cost of college attendance. As a result, more and more students have come to rely on private loans to cover the gap between their cost of attendance and the financial aid they’ve been awarded.

Private loans can be helpful sources of college funding, but they should be approached with caution and as a last resort for funding. Private loans, like federal student loans, cannot currently be discharged in bankruptcy except in rare circumstances, but unlike federal student loans, they tend to carry higher interest rates and have few to no loan forgiveness options available to borrowers. If students run into trouble with repaying their private loans (and student loan default rates have recently been on the rise), they can quickly balloon into a lifelong financial burden.

This doesn’t mean you need to avoid them entirely or adopt a strictly pay-as-you-go approach to funding your education; just be sure to investigate scholarship opportunities and other forms of financial aid before committing to a private loan. Finally, choosing wisely among your private loan options can help you minimize your overall student loan debt.

Bank-Based Private Loans

Private loans originated by banking institutions have traditionally been the main source of alternative funding for college degrees. Major lending institutions, which often also participate in federal student loan programs, offer loans with variable interest rates and repayment terms that typically begin six months after college graduation (though in 2009, Sallie Mae started requiring students to begin repayment while still in school). The number of private loan offerings grew greatly in the late 1990’s and early 2000’s, with numerous lending agencies, including several companies specializing in private student loans, entering the college loan market with varying loan options and sales pitches.

However, problems in the banking industry caused many banks and lending agencies to cease participating in student loan programs, while others raised interest rates and credit requirements. As a result, students are finding it more difficult to get a private loan from a bank or other traditional lending institution than it was just a few years ago. Still, there are banks lending to students, and those who are interested in pursuing this option can find more information now than ever to compare loan rates and repayment information, thanks to legislation passed by Congress requiring clearer disclosure of terms.

Credit Unions

While credit unions had been offering student loans before the recession, the near-collapse of private student lending has prompted many to enter the student loan market in a bigger way. Some credit unions are partnering with state higher education agencies to ensure students are able to access college funding. Others are participating in programs to help get the word out to students in their area that they are offering student loans. Loans from credit unions often carry lower interest rates and more favorable repayment terms than bank-based private loans, but they are still relatively scarce. Students who are able to take advantage of private loans from credit unions will likely qualify based on a credit check and will complete an application process similar to that of a loan from a private bank.

Peer-to-Peer Lending

The newest player in the private student loan marketplace is peer-to-peer lending, alternative student loans made directly to students by individuals through a website that brokers deals and draws up contracts. These loans can have substantially lower interest rates than private loans, and can potentially be made among friends and family members, codifying what previously would’ve been an informal arrangement. Several websites have been launched in recent years that operate on some variation of this model, using a variety of means to match lenders and students. These sites typically charge some sort of fee for brokering a loan deal, but for students able to attract investors in their education, they can be a great opportunity.

State Agencies and Other Sources

Like banks, state higher education agencies have been impacted by the recession. While many states formerly offered low-interest private loans for state residents, options have become more limited since 2008. Some state higher education agencies, private foundations, and other philanthropic organizations do still offer low-interest or no-interest student loans to students who meet certain qualifications. Students going into high-need fields of public service are most likely to encounter these loan opportunities.

A common term used by state agencies and philanthropic organizations is “scholarship loan,” which can describe two kinds of loan programs. One type is a student loan with no interest or a nominal interest rate, which allows students to borrow for college more cheaply but requires repayment. The other, more common, variety is a loan that can be repaid either in cash (often at a flat rate, which could still be favorable for borrowers) or through public service. This variety is often offered to future teachers and healthcare professionals.

Last Reviewed: May 2017

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