The Pitfalls of a Private Student Loan

The Pitfalls of a Private Student Loan

NEW YORK (AP) — Faced with last-minute college costs, it's tempting for families to turn to private student loans this time of year.

The danger is that borrowers may assume they come with the same terms as federal student loans. But the loans doled out by banks are far inferior; they're costlier and don't carry as many protections in case borrowers run into financial trouble.

If you're thinking about taking out a private student loan, here's what you should know.

How They Work

Don't expect to waltz into a bank and borrow as much walking-around money as you like.

Private student loans are generally capped to your college's cost of attendance, minus any aid you already have. Lenders will ask your school to certify that the loan amount is in line with your needs. The loan is then disbursed to the financial aid office, which will likely dispense money to you once a semester. Depending on how the loan is set up, a school may apply the loan to tuition or other bills for you.

You'll also need a co-signer unless you can prove you have the means to repay the loan. The better the cosigner's credit score, the better the interest rate you'll get.

Remember that you can no longer get federal loans through private lenders. A new law this year consolidated the government's program and cut private lenders out of the process. Federal loans are now disbursed only through college financial aid offices.

Interest Rates

A big drawback with private student loans is that you can't lock in an interest rate. Instead, you get a variable rate that rises and falls with the movement of a certain benchmark, such as the prime rate charged by banks.

Since these benchmarks are at historic lows, any rate you're offered today by a bank is likely to climb. The average rate on private loans is currently between 8 percent and 8.5 percent, according to Student Lending Analytics.