RISKS OF TAKING OUT PRIVATE LOANS

There is always the option to use a private loan instead of Stafford Loans. Also when a student has used all their Stafford eligibility for a year they may have a need for more loans. Many students assume that they may only apply for a private loan or that their parent for some reason chooses not to apply for a Parent PLUS loan.

It is always recommended that a student use all their Stafford loan eligibility before tapping into the other types of loans. If you are pursuing an alternative loan because of bad credit, you should consider applying for a PLUS loan anyway. If you are denied a PLUS loan for credit reasons, your child becomes eligible for higher Stafford Unsubsidized loan limits.

Here we list some of the reasons why the PLUS Loan has more incentives and also why one may choose private a private loan. 

  • Interest Rates. The interest rate on the PLUS loan is often lower than the rates on home equity loans, although both rates are in the same ballpark. The PLUS loan is also less expensive than most private student loans. The PLUS loan interest rate is fixed while private student loans and home equity lines of credit typically have variable interest rates. PLUS loans typically offer an interest rate discount of 0.25% if you agree to have your monthly payments automatically deducted from your checking account.
  • In-School Deferments. Many alternative loans allow the parent to defer payments while the student is in school and for a short grace period after graduation. The Ensuring Continued Access to Student Loans Act of 2008 gives parents the option of deferring repayment while the student is in school and for a six month grace period after the student graduates or drops below half-time enrollment. In both cases deferring payments substantially increases the size of the loan since interest continues to accrue and is added to the loan balance when the loan enters repayment. You can also obtain economic hardship deferments and forbearances on a PLUS loan.
  • Interest Tax Deduction. Home equity loans and lines of credit are tax deductible, if the taxpayer itemizes deductions on Schedule A of the 1040. This includes the interest on up to $100,000 of a HELOC used to pay for items other than improvement of the home, such as paying for college. On the other hand, the taxpayer can deduct up to $2,500 a year in student loan interest even if he or she doesn't itemize.
  • Responsible Party. The parent is responsible for repaying the PLUS loan. The student is not responsible for repaying the PLUS loan, although many parents enter into agreements with their children to have them make the payments on the loan. In contrast, many alternative loans make the student responsible for repaying. However, those loans often require the parent to cosign the loan, making the parent responsible for repaying if the student should fail to make timely payments on the loan.
  • Availability. About 70% of parent and graduate/professional student borrowers will qualify for a PLUS loan. The adverse credit history requirement is not as stringent as the criteria used for private student loans. Subprime borrowers (borrowers with FICO scores under 650) will generally not qualify for most private student loans. Note that PLUS loans and unsubsidized Stafford loans are available without regard to financial need.
  • Impact of Default. If one defaults on a federal education loan, the government can garnish wages and social security payments, and attach income tax refunds. Student loans are generally not dischargeable in bankruptcy. On the other hand, if you default on a home equity loan or line of credit, the lender can take your home.

      
Options for Relief for Borrowers Encountering Financial Difficulty

This chart illustrates some of the main options for relief for borrowers who are encountering financial difficulty.


Options for Relief


Federal Loans


Private Loans

Extended Repayment

10 to 30 years

In limited cases, 15 to 30 years. Most lenders already at max term of 20 or 25 years.

Graduated Repayment

Yes

No

Income-Contingent Repayment

Yes

No

Income-Sensitive Repayment

Yes

No

Income-Based Repayment

Starts July 2009

No

Loan Forgiveness Programs

Yes

No

In-School Deferment

Yes, unlimited

Yes, limited

Economic Hardship Deferment

Yes, 3 year cap

No

Forbearance

Yes, 3 year limit

Yes, 1 year limit

Closed School Discharge

Yes

No

Discharge for Death of Student

Yes

No (a few exceptions)

Discharge for Student Borrower's Total and Permanent Disability

Yes

No

Bankruptcy Discharge

Undue hardship

Undue hardship

     
Why do people borrow private student loans instead of federal education loans?
These maybe some of the reasons why a student chooses to utilize a private loan.

  • Lower monthly payments.
  • Better marketing.
  • Bureaucracy and Privacy.
  • Confusion between federal and private loans.
  • Familiarity.
  • Lack of awareness of differences in cost.
  • Confusion about eligibility.
  • In-School Deferments.
  • Stagnant annual and cumulative Stafford loan limits.
  • Preference for student borrowers.
  • Failure to make Satisfactory Academic Progress.
  • Institutional eligibility.

 

Last Modified - 5/18/2011

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