4 Reasons to Avoid Private Student Loans

By Maurie Backman Markets Fool.com

There's a reason college students are racking up so much debt. The College Board reports that tuition and fees for the 20162017 school year averaged:

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  • $33,480 at private colleges
  • $9,650 at public in-state colleges
  • $24,930 at public out-of-state colleges

These figures, however, don't include room and board, which can easily add $10,000 per year to the cost of higher education. And because most students, along with their families, can't swing those bills on their own, they often have no choice but to borrow money to attend college.

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But not all student loans are created equal, and unfortunately, a large number of college hopefuls are resorting to private loans instead of federal loans to fund their education. During the 2011-2012 school year (the last year for which this specific data is currently available), almost 1.4 million students took out private loans. This represents a big jump from the 2003-2004 school year, during which only 930,000 students went this route. And while it's true that many students resort to private loans after exhausting their federal borrowing options, this isn't always the case. In fact, for the 2011- 2012 school year, 47% of those who took out private loans borrowed less than they could have in federal Stafford loans.

While taking out private loans may seem like a reasonable or even appealing option for funding a college degree, there are several drawbacks to this approach. Here are a few reasons to steer clear of private loans.

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1. No borrower protections

When you take out federal loans, you're obviously required to pay that money back. But federal loans come with a number of borrower protections, including deferment and income-based repayment plans, that give borrowers more flexibility. Private loans, by contrast, don't usually offer such protections, which means if you run into financial trouble, you'll be on the hook for those payments regardless.

Furthermore, with a federal loan, you won't be required to make payments on what you owe until you graduate college, withdraw from your studies, or change your enrollment status to less than half-time. Private loans, on the other hand, often require you to start making payments while you're still in school -- regardless of whether you have an income.

You should also know that private loans can't be dismissed as part of a bankruptcy proceeding. While the same holds true for federal loans, you'll typically get some sort of allowance to temporarily postpone or lower your payments if you're struggling financially. Private lenders aren't as quick to grant such courtesies, and without the option to eliminate your payments via bankruptcy, you could wind up facing wage garnishments or, worse yet, costly lawsuits.

2. Variable interest rates

Federal loans come with preset interest rates, so when you take out a federal loan, it's easy to predict what your monthly payments will be over time. Private loans, however, often come with variable interest rates, and while those rates might seem attractive at first, they have a tendency to climb over time. In fact, it's not unheard of for private loan interest rates to double or triple over the course of their associated repayment periods, and when this happens, your payments could skyrocket.

3. No borrowing limits

Federal loans impose strict limits on how much you're allowed to borrow, which can be instrumental in helping students keep their debt to a minimum. Currently, dependent undergrads can borrow up to $31,000 in federal loans, while independent undergrads can take out up to $57,500. Graduate students, meanwhile, can borrow up to $138,500. Private loans, however, aren't capped in the same manner, which can open the door to temptation and cause unsuspecting students to overborrow.

4. Your lack of credit might cost you

Most federal loans (with the exception of PLUS loans) don't require a credit check as part of the application process. As such, you can typically qualify for a federal loan without requiring a cosigner, and the rate you lock in will be whatever the going rate is at the time. Private loans, on the other hand, often require borrowers to go through a credit check. But most students don't have a strong credit history at the time they apply, and if that's the case, you could get slapped with a higher interest rate. Furthermore, you may need a cosigner to get approved for a private loan in the first place.

Before you take out a private student loan, make sure you exhaust your federal options completely. But more so than that, make sure you really understand what you're signing up for prior to committing to a borrowing agreement. If you're not careful, you could wind up in debt way over your head before you've so much as managed to step foot inside a lecture hall.

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