Three Reasons to Avoid Private Student Loans

Education is a necessity in a growingly competitive marketplace, but at what cost? By 2018, the average cost of attending a public university will total roughly $180,000—and that’s the bargain price for in-state students. Although average tuition is not yet astronomical, the trend of rising prices is growing. Many students apply for federal student loans to help soften the blow of immediate expenses. This government-backed option provides students with the maximum amount of funding at a fixed (and often, low) interest rate. Their repayment terms are also based on a student’s income after graduation.

Federal education loans sound perfect, right? Unfortunately, they rarely cover all student expenses, especially those who are attending school without parental help. This is where private loans come in. Unlike federal loans, these are guaranteed by private banks or other lenders such as Sallie Mae. They often come with higher, variable interest rates and no income-related payment options. Despite their obvious pitfalls, thousands of students take out these types of loans each year. Read on to learn why you should avoid joining the group.

While it’s true that private student loans facilitate education, few realize the larger consequences of signing up for mortgage-sized debt. Private student loans could:

• Bury your finances. Private loan repayment is based on the loan amount—not your income. This fact poses a problem for new grads struggling to balance their budget on an entry-level salary. Consider the following example:

  Caz recently earned a degree in civil engineering from a Top 20 university. Despite his long-term earning potential, his current salary is $51,000 a year. Nearly a third of his monthly income is used to repay a private loan debt of $80,000.

Just as Caz learned, private loans with variable interest rates can put a huge dent in even the most respectable income. Before collecting funds, think about your needs after college and decide what you can afford.

• Ruin your credit. Consider credit repair before you need it by saying “no thanks” to private loans. Although the private loan option provides a six-month grace period, repayment may still be a struggle. Those who are unprepared to face large monthly payments face late fees, fines, and even default. In addition to legal action and possible wage garnishment, all of these consequences could damage your credit score for up to seven years.
• Limit your buying options. The short list of the American dream usually includes a good job, steady family life, and of course, the perfect house. Unfortunately, private loans could present several challenges along this well-paved road. Mortgage lenders use the 28/36 Rule to determine how much a borrower can afford to spend. This rule suggests that a borrower should never spend more than 28 percent of their gross monthly income on housing costs, including the mortgage, insurance, and property taxes. These same costs should never exceed 36 percent of all household debt, including student loans, car loans, credit cards, etc. Students saddled with thousands in student loan debt will find it difficult to abide by this guideline. As we learned from Caz’s predicament, private lenders pay no attention to income-based repayment.

For all of these reasons, don’t begin your career struggling with credit repair. Search for scholarships, grants, and other alternatives before succumbing to private student loan options. This could save you from years of credit repair and countless worries.