What is a private student loan? A quick guide

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If you need help paying for college, there are a lot of types of loans that can help you fill in the gaps. Federal student loans generally offer more favorable repayment¹ terms, while private student loans can offer low interest rates based on your credit profile. Here’s what you need to know as you figure out the best way to finance your child’s education.

What is a private student loan?

A private student loan is a non-federal loan issued by private lenders, such as banks, credit unions, or other financial institutions. These loans are designed to help students cover the cost of their education. That could include tuition, fees, room and board, and other related expenses.

Unlike federal student loans, which are funded by the U.S. government, private student loans are not subject to the same regulations. As a result, they often come with different terms and conditions, which can vary significantly from lender to lender.

Private student loans vs federal student loans

Though both private and federal student loans offer borrowers a way to pay for college, they have some pretty significant differences. Here’s what you should know before you take out a private student loan².

Interest rates

Federal loans all have fixed interest rates. A fixed interest rate is a rate that remains constant throughout the life of a loan. As in, the interest rate does not fluctuate or change, regardless of changes in the market or economy.

The benefit of a fixed interest rate is that it provides predictability and stability for borrowers. Since the student loan interest rate remains constant, borrowers know exactly how much they’ll pay in interest over the life of the loan, which makes budgeting and financial planning easier.

Private loans, on the other hand, can have fixed or variable interest rates. Also known as adjustable interest rates, variable rates change as the market does.

Obviously, this can make financial planning difficult, but the upside of variable rates is they often start lower than fixed interest rates. If the borrower plans on paying off their loans over a short period of time, they may be able to save money on interest before interest rates rise. But it’s a gamble, as rates may rise before you’re able to pay off your loans, which could result in more money paid in interest over time. Generally, it’s recommended that if you can find a reasonable rate on a fixed-rate loan, it’s a better choice than a variable-rate loan, even if that variable rate is slightly lower.

Credit check

Most federal student loans don’t require a credit check. The amount that you’re able to borrow and the interest rate are based on factors like financial need and the borrower’s school –– not credit history.

On the other hand, private student loans always require a credit check. This involves the lender pulling the applicant’s credit report and evaluating their credit history to determine if they’re a responsible borrower. The higher the credit score, the more responsible the applicant will appear to lenders, and a low interest rate they may be eligible for. 

Cosigner

Since most students don’t have sufficient credit history to get approved for a private student loan, they may have to apply with a cosigner. A cosigner is someone who agrees to be legally responsible for the debt should the borrower not be able to repay their loan for any reason.

With a cosigner, a lender can be confident that even if the borrower can’t repay the loan, the cosigner will –– and that can make all the difference in getting approved. A good cosigner is someone who has a good credit score. When you apply with a cosigner, you could get a better interest rate.

On the other hand, federal student loans do not require a cosigner. However, Federal PLUS Loans (loans for graduate school) may require an endorser if the applicant has an adverse credit history. A credit check is required for PLUS loans, and without a great credit score, the borrower may need an “endorser.” Though it’s a different term, an endorser is essentially the same thing. 

Should I get a private or a federal student loan?

In general, you should maximize the amount of financial aid you can get from the federal government before you consider private education loans. This is because the Department of Education has protections in place to help prevent borrowers from defaulting on their loans. It offers particularly favorable and flexible repayment plans for both graduate and undergraduate students.

Dependent undergraduate students can borrow up to $7,500 per year in Direct Loans, with lower limits for first- and second-year students and higher limits for upperclassmen. Graduate students can borrow up to $20,500 annually in Direct Unsubsidized Loans and may borrow additional funds through Grad PLUS Loans to cover the full cost of attendance. 

Parents and graduate students can borrow additional funds through PLUS loans—which have a higher interest rate—to make up the difference between Direct loans and the full cost of attendance, including living expenses.

Depending on your financial situation, you may be eligible for subsidized loans that do not accrue interest while you’re in school. To find out what’s available to you, you can fill out the FAFSA (Free Application for Federal Student Aid), which will assess your family’s finances.

Here’s what you should consider as you decide between loan options.

Why federal loans are more favorable than private loans

• Federal loans offer income-driven repayment plans³ that make it easier to lower your monthly payments if you can’t afford them.

• Federal loans, including graduate student loans, have lower eligibility requirements—virtually every student who is a U.S. citizen or permanent resident qualifies for these loan programs without needing a creditworthy cosigner or a credit check.

• If you work in a qualifying public service industry, you may eventually be eligible for loan forgiveness.

• As long as your enrollment in school is at least half-time, you won’t be required to make loan payments (note, however, that interest will still accrue on unsubsidized federal loans).

• You can always apply to refinance federal loans later to try to save money on interest, once you’re in a secure financial position to pay them off⁴.

• Federal loans have deferment and forbearance options that may be easier to access during periods of financial stress.

How much can I get in private student loans?

The total loan amount you can borrow in private loans is essentially limited by your credit score and financial situation and may vary significantly from family to family and lender to lender.

It’s possible that you may be eligible for, say, $10,000 from one lender, and $10,000 from another. There’s nothing to stop you from borrowing from both of them. However, it’s wise to think carefully about how much you borrow and what the loan terms are, so that you can be sure you’ll be able to meet the repayment terms.

After the disbursement of a private loan, the amount you’ve borrowed will show up on your credit report and could impact your credit score. This is because borrowing money increases your debt-to-income ratio, and borrowing too much may make you look like a risky bet. Paying down other debts, including the amount of money you have outstanding on your credit cards may help you access more student loan funding.

How long does it take to get a private student loan?

Once you’ve filled out a loan application with a student loan lender, it can take a few days or a few weeks to get everything squared away. If you have a high credit score and a straightforward application, you may be approved quite quickly. However, it may still take some time between the application and origination of the loan, which is when your money is disbursed.

The amount of money you’re borrowing and how you want it to be disbursed could impact this timeline. In most cases, the money will be sent straight to the university. In others, you may need cash deposited in your checking account, so that you can use it to cover living expenses on campus.

How do I get a private student loan?

Before you apply for a private student loan, the first step is to examine your options. You should do some research on the companies out there offering loan terms that make sense to you.

Often, you can check your interest rates on these loans before submitting an official application, which means the company will do a “soft” credit check instead of a hard credit pull. This won’t impact your credit score, and it’s a great way to see what’s available to you before you start the application process.

Here are the steps you’ll generally need to take in order to apply for a loan:

• Determine exactly how much money you need to borrow. Do some budgeting so you can make sure you’re borrowing only exactly what you need so that you don’t pay interest unnecessarily.

• Research lenders. You’ll probably be with this company for around 10 to 15 years –– potentially even longer –– so you want to make sure it’s the best option available to you. Aside from the interest rate, consider how easy it is to get in touch with customer service when needed, and what options the company has available if the worst happens and you can’t make your payments. Earnest lets borrowers in good standing apply to skip a payment⁵ once a year if a financial emergency comes up.

• If you have time before applying, work on your credit score. Generally, the higher your credit score is, the lower your interest rate can be. If you have time to pay off old debts or increase your credit score in other ways, this can save you money in the long run.

• Choose the best lender for you and submit an application. The application process will vary from company to company but may be as simple as filling out a short form that takes just a few minutes.

• After approval, your money will be sent to you or the university. Depending on what kind of loan you applied for and why you needed it, you may be able to choose whether the money goes directly to you or to the university.

After disbursement, make payments once they’re due. Many lenders offer borrowers a grace period so that they don’t have to make payments while the student is enrolled in school. Earnest offers a generous grace period⁶ allowing students to wait up to 9 months after graduation to start making payments. Interest will accrue during this time, so you can save money over time by making small payments to decrease the amount of interest that accrues and start reducing the principal balance.

Learn more about Earnest private student loans

If you’re considering a private student loan, it’s important to research multiple lenders –– not only to get the best rate possible but to find a lender who can help when things get complicated.

Earnest offers flexible repayment options and terms. We never charge any kind of fees, including late fees. You’ll also get a nine-month grace period — higher than the six-month standard offered by other lenders. Find out if you're eligible for a private student loan through Earnest today. 

Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.

1 As was announced by the U.S. Department of Education (ED), federal student loans have resumed accruing interest starting September 1, 2023, and federal student loan payments were reinstated starting in October 2023. Please note that you may lose benefits associated with your underlying federal loans, such as federal Income-driven Repayment Plans (an example of which is the SAVE plan), Economic Hardship Deferment, Public Service Loan Forgiveness, or other deferment and forbearance options, if you refinance into a private loan. If you file for bankruptcy, you may still be required to pay back this loan. See https://studentaid.gov/ for more information.

2 Before applying for private student loans, it’s best to maximize your other sources of financial aid first.  It’s recommended to use a 3-step approach to assembling the funds you need: 1) Look for funds you don’t have to pay back, like scholarships, grants, and work-study opportunities.  2) Next, fill out a FAFSA(R) form to apply for federal student loans.  Federal Direct subsidized and unsubsidized loans, excluding PLUS Loan for Parents and PLUS Loan for Graduate and Professional Students which require a credit check and a credit worthy endorser if the parent or graduate or professional student has adverse credit, do not require a credit check or cosigner, and offer various protections if you're struggling with your payments.  3) Finally, consider a private student loan to cover any difference between your total cost of attendance and the amount not covered in steps 1 and 2.  For more information, visit the Department of Education website at https://studentaid.gov/.

3 As a result of ongoing court actions, the terms of some Income-Driven Repayment (IDR) plans, including the SAVE plan, may be subject to change. Please refer to studentaid.gov for the current status of these plans.

4 Choosing to refinance to a longer term may lower your monthly payment, but increase the amount of interest you may pay. Choosing to refinance to a shorter term may increase your monthly payment, but lower the amount of interest you may pay. Review your loan documentation for the total cost of your refinanced loan.

5 Earnest clients may skip a payment through a one, one-month forbearance during a 12 month period. Your first request to skip a pay can be made once you’ve made at least 6 months of consecutive on-time full principal and interest payments, and your loan is in good standing. The interest accrued during the skipped month will result in an increase in your remaining minimum payment. The final payoff date on your loan will be extended by the length of the skipped payment periods. Any unpaid accrued interest may capitalize (added to the principal balance) at the end of the forbearance period by adding unpaid accrued interest to the outstanding principal as permitted by law and the terms of the loan agreement.  

6 Nine-month grace period is not available for borrowers who choose our Principal and Interest Repayment plan while in school.