And no finance-related topic has caused as much stress in my life so far as the process of securing a private student loan.
Entering my senior year at a private university, I’ve been fortunate enough not to need a private student loan – until now.
This year, my family and I applied for a private student loan for the first time.
There was so much about the process that I didn’t know, and I asked a lot of questions until I wrapped my head around what it all meant. I hope my experience can help you navigate yours.
Where do you even start applying for private student loans?
I can tell you that six months ago, I had no idea. To answer, let’s rewind … way back to the spring before the semester for which you need the loan. Because that’s when you fill out a FAFSA (free application for federal student aid) form and submit it to your university.
After you do this, the university will tell you how much it can provide in financial aid grants, scholarships and whether or not you are eligible for federal subsidized and unsubsidized student loans. These federal loans are called Perkins and Stafford loans and will have interest rates of between 3.4 percent and 6.8 percent, based on whether they are subsidized or unsubsidized. The FAFSA is the most crucial step in the financial aid process, and to complete it successfully you have to stay organized and think ahead. For example, if you will be an entering freshman, you have to complete the FAFSA during the spring of your senior year of high school. Also, consider applying for any scholarships for which you may be eligible.
To help us figure out this process, we used the helpful book “Paying for College Without Going Broke.”
The need for private loans: Cost minus federal aid and scholarships
With the results of what aid your university and federal loans can provide, you’ll still need another piece of important information: the school’s official “cost of attendance.” That price tag should be listed on the university’s website (probably the financial aid section) and includes tuition, room and board, any automatically charged student fees (an athletic event or health fee, for example), transportation costs to and from school, books and supplies, and usually a “miscellaneous” category. This gives you a more accurate vision of what the overall cost of attending school for one year will be (rather than the much lower tuition number alone).
Subtract your financial aid, government loans and outside scholarships from this number, and the total is the approximate private loan amount you’ll need for the year. Of course, you want this to be as low as possible to avoid excessive interest, but also realistic so you don’t run out of money. So you should factor in additional income you could make during the summer and any income you’ll have during the school year to lower the total amount you need to borrow.
OK, so now you have the private loan amount in mind. What’s next?
This is the part that confused me the most. At first it seems hard to know what a “good” loan for you will be.
I pictured myself walking into my local bank and chatting with a rep about my options. This was not at all accurate.
Choosing which loan to apply for actually requites a LOT of Internet research.
We used this helpful chart showing different loan options as well as quite a bit of good-old Googling. Both proved useful to get a range of what rates are typical.
One place to start – if your parents are willing to borrow on your behalf — is the federal parent PLUS loan. PLUS loans tend to have more favorable terms because as the name suggests, a parent has to apply for it in his or her own name. That means your mom or dad must be willing and must have good credit.
If you have to rule that one out, there are still many remaining private loan options. The downside is these loans are almost always more expensive. Here are some factors to consider:
Can you sign alone?
One factor that will affect your options is whether or not you’ll be able to have a cosigner. If you can get a cosigner with a good credit score, your private loan options will be brighter.
Choose your rate: Fixed variable?
Another important question is whether to choose a fixed or variable rate loan.
Variable rates are tempting when they’re low (as they are now), but remember you’ll be paying this loan for ten or more years, and rates can go up — a lot – during that time.
We went with a fixed rate.
Obviously we don’t know what will happen to interest rates without the help of a crystal ball, but if you can get a reasonably low fixed rate, it’s a reliable way to go.
Consider the repayment terms
When you’re choosing a loan, consider the repayment period and grace periods (how long you have to pay the loan back, and how long after graduation you have until they’re due). It’s tempting to pay back as soon as possible, but that’s not always realistic or smart.
Maybe you already have an investment banking job lined up after college and can pay them off super quickly with no problem. Great! But if not, taking 10 to 15 years is probably a better idea. You can use a simple loan calculator like this one to see see what your monthly payment would be over different periods of time. (We calculated one and realized it meant a payment of over $1,000 per month. No, thanks!)
We also wanted to make sure we didn’t pick a loan that charges a penalty for early repayment. What if you can comfortably pay back the loan in eight instead of 10 years? That should only be a good thing. You don’t want to get slapped with a fee for doing that, and – believe it or not — several banks will give you one.
Avoid fees and seek out perks
We also wanted a loan with low or no origination fees. Some banks charge an “origination fee,” or automatic charge for taking out the loan, usually presented as a percentage of what you’re borrowing. And it can really add up! One charges up to six percent for the origination fee; if you’re borrowing $25,000 for a year, that’s $1,500. So make sure you check that part out before you commit.
Sometimes there are benefits to certain loans, as well. Some banks will give you a reduced interest rate for opening a bank account with them (I’m doing this at Sun Trust Bank). Some give you a little reward just for graduating. Some will let you start paying the interest off before you start paying the actual loan amount. Gather as many of these as you can. They’re what makes a “good” loan better than the rest.
Now’s the time to be The Bachelor/Bachelorette
I know, I hate those shows too.
But it’s the only analogy that comes to mind. In the show, the bachelor/bachelorette dates several individuals before deciding which he/she is going to choose. You’re going to do the same thing with the banks.
Apply for a few different loans simultaneously. Before you do this, you’re only going to have an estimate of how much you’ll be paying. The bank has to consider several factors (your cosigner if you have one, your credit score, and your application) before telling you for sure what your interest rate will be. When this happens, you want options. The bachelor who looked so good on paper might unexpectedly show you his disgusting Cheeto-strewn room during “hometown dates.” You never know.
When the banks get back to you with their offers, you can be selective. Pick which one looks good and give it “the rose.” Tell the others you’re no longer interested, by communicating with them AND your university, making sure all parties are aware of which loan you want to take.
As a final step, read the documentation that comes with your chosen loan carefully. You will have to sign a promissory note that is your commitment to repay the loan. This note will include detailed information about how much interest you’ll pay, when it begins accumulating, and what will happen if you don’t pay as agreed. Most banks (and colleges) are all too eager to rush students through this process – and let’s be honest, it’s usually just a distraction from picking your classes and finding the next keg – but being smart with money starts with understanding what you’re signing!
And you’re done! Until you have to start paying them back, of course.
Was that so bad? It’s not light reading, but understanding your loan before you take it allows you to be in control.
In my case, repaying the loan will be my responsibility, so I’m glad I was invested in the process of choosing which loan was right for me.
I hope this post will serve as a road map through the student loan application process. If I could add one last piece of advice: leave yourself enough time so that you don’t have to do this all in one sitting. Take your time to read about other people’s experiences, review literature, and act when you’re ready.