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A private student loan is a financing option for higher education in the United States that can either supplement or replace federally guaranteed loans such as Stafford loans, Perkins loans and PLUS loans. These may offer forbearance and deferral options. Fees vary greatly, and legal cases have reported fees reaching 50% of amount of the loan. Although traditionally unsecured, these loans are increasingly secured, so that the borrower must offer collateral or a third-party guarantee of payment.

Interest rates are set by the financial institution that underwrites the loan, typically based on the perceived risk that the borrower may be delinquent or in default of payments of the loan. The underwriting decision is complicated by the fact that students often do not have a credit history that would otherwise indicate creditworthiness. As a result, interest rates may vary considerably across lenders.

Because private student loans are subject to special treatment in the event of a personal bankruptcy, students may not incur a total debt in excess of the cost of attendance, taking into account scholarships, fellowships, federal loans and private loans.

Private student loan types

Private student loans generally come in two types: school-channel and direct-to-consumer.

School-channel loans offer borrowers lower interest rates but generally take longer to process. School-channel loans are certified by the school, which means the school signs off on the borrowing amount, and the funds are disbursed directly to the school.

Direct-to-consumer private loans are not certified by the school; schools don t interact with a direct-to-consumer private loan at all. The student simply supplies enrollment verification to the lender, and the loan proceeds are disbursed directly to the student. While direct-to-consumer loans generally carry higher interest rates than school-channel loans, they do allow families to get access to funds very quickly — in some cases, in a matter of days. Some argue that this convenience is offset by the risk of student over-borrowing and/or use of funds for inappropriate purposes, since there is no third-party certification that the amount of the loan is appropriate for the education finance needs of the student in question.

Direct-to-consumer private loans was the fastest growing segment of education finance with the percentage of undergraduates obtaining private loans from 2003–04 to 2007–08 rose from 5 percent to 14 percent and were under legislative scrutiny due to the lack of school certification. Loan providers range from large education finance companies to specialty companies that focus exclusively on this niche. Lenders often push such loans by advertising: no FAFSA required, or Funds disbursed directly to you. But since the passing of Health Care and Education Reconciliation Act of 2010(HCERA), the death knell sounded for private sector lending under the Federal Family Education Loan Program (FFELP). Since July 1, 2010, no new student loans have been made under the FFELP; all subsidized and unsubsidized Stafford loans, PLUS loans, and Consolidation loans have been made solely under the Federal Direct Loan Program.

The biggest student loan lender, Sallie Mae, was formerly a government sponsored entity turned private between 1997-2004. A number of financial institutions offer private student loans, including banks like Wells Fargo, and specialized companies.

As the economy collapsed through 2008-2011, many players withdrew from the private student loan lending world. Remaining lenders tightened the credit criteria making it more difficult to receive a loan. Most now require a credit worthy cosigner.

Buying factors include:

  • Interest rates throughout the life of the loan lenders may accrue interest at one rate while the student is in school and another after graduation
  • Payment options lenders typically offer loans that are payable immediately, interest-only loans while the student is enrolled, and no-payment loans until graduation
  • Incentives lenders may offer improved or tougher terms based on the student s payment record
  • Origination fees lenders typically charge a fee for originating the loan that is added to the principal of the loan.

The total cost of the loan is usually documented in the Truth in Lending statement that is issued when the loan is originated.

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