Private Student Loans: Borrower Beware

Michael Lux Blog, Student Loans 0 Comments

Far too many college financial aid offices and high school guidance counselors rely on a very dangerous view of college financial aid.  They properly view private student loans as being a last choice for funding an education, but they see this as being the appropriate route to fill a the gap between an existing financial aid package and the cost of attendance.

Before a college student, and often their parents, sign up for a private student loan, there are many important factors that should be considered.

Can I afford to pay back this loan?

This question seems like a very obvious one to ask, but it almost never happens.  Just like you wouldn’t buy a house without knowing what your mortgage payments will be, or buying a car without knowing how much you owe each month; you need to know what your monthly student loan payments will be when you graduate.

Unfortunately, the math isn’t simple or straightforward.  The private loans you borrow as a freshman will likely be the same private loans you borrow for the next three or four years.  When you repay the loans you will be paying back much more than just the principal balance.  The loans you borrow years before you graduate will have grown significantly while you were in school due to interest.  As you repay the loan, a large portion of your payment will go towards interest.  These payments that are mostly interest payments merely represent profits for your lender and do little to knock down your balance.  If you sign up for a variable-rate student loan, which are the most common, your interest rate could go up over the years making your debt even more expensive.

What happens if I can’t find a job or don’t make enough money?

Federal student loans have programs like income-driven repayment and loan forgiveness.  Private student loans have no such protections.  With many lenders the best you will be able to do is a short deferment if you have a financial hardship.  During this time you may not be making payments, but your balance will still grow.  If you can’t afford the payments, your credit score will be impacted, your wages may be garnished, and it could make finding a job even harder.

Nobody goes off to college expecting not to graduate or thinking they won’t find a job in their field, but it happens to millions of people every year.  If you are smart enough to get your degree and find a good job, then you are smart enough to plan ahead just in case things don’t work out.

It is also worth noting that there are special rules regarding bankruptcy and student loans.  Unlike a car loan, mortgage, or credit card debt, student loan debt is almost impossible to discharge in a bankruptcy proceeding.  That means the debt will follow you for life if you cannot afford to pay it.

Am I willing to accept the consequences of having this debt?

Even under the best circumstances, student loans can have major consequences on your finances.

In addition to the large monthly payments that you will have for years, it will also limit your ability to borrow money in the future.  Student loans have a major impact on your debt-to-income ratio.  When a mortgage company or other lender makes a credit decision, they look at this number.  If you have a ton of debt, it can often mean denials or higher interest rates.  Many student loan borrowers find that their debt is the reason that they have to delay getting married, buying a house, or having children.

Keep in mind that student loan debt shows up on the credit report of your cosigner as well.  That means they will have the same issues with regard to debt-to-income ratios as well.

Bottom Line

Borrowing private student loans is easy.  Paying them back is the hard part.

Before you sign on for the debt, make sure you think things through carefully.  Many people come to regret their student loans as the biggest financial mistake of their life.  Make sure this doesn’t happen to you.