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Beware Private Student Loans!

Posted on | December 21, 2009 |

Private Student Loans were big business, until 2007-2008.

The number of private loans has grown more than 3 times in the past decade, going from 7% of all loans in 1998 to 23% in 2008. Then the credit crunch hit, and private loans market dried up for a while. Now, private loans are making a come back and this new round is more expensive and harder to get.

Federal loans have fixed rates, and flexible repayment terms, but private loans are often variable rate (usually in the double digits when all is said and done) and are less flexible in repayment.

Because of this, you should avoid private loans where you can by maxing out federal loans first, and then only use private loans sparingly if you cannot avoid them altogether.

4 things to watch for with private student loans.

1. Cosigning.

Cosigning is best avoided, if it can be. The problem is that most students don’t have a credit history, or if they do it’s likely to be lacking. So they often come to mom or dad to cosign. Two things to know about cosigning your child’s student loan: 1) Lenders usually look for a credit score of at least 700, if you fall short you can be denied or have to pay a higher rate. 2) If junior misses even a single payment - you’ll be on the hook to make it for him.

2. Interest rates.

The base interest rate for a student loan is pegged to either the LIBOR index, or the prime rate, plus a margin. This added margin is how the lender makes his profit, since it’s the difference between the cost of the money he’s lending you and the amount you’re paying back. This margin depends on the applicant and cosigner’s credit history.

3. Total costs.

When deciding on a private loan, look at the total costs and not just the interest rate. This is true of any loan really, but it’s especially important with private student loans. Consider any fees and how often interest is calculated and added to the loan. The annual percentage rate (APR) includes those factors as well as the interest rate, but can be misleading. For example, the number may be different when the student is in school than when he is in repayment.

4. Shop around.

It’s important to shop around for the best deal from the best lender, but don’t shop too much. Applying for too many loans in a short period of time can look bad on your credit report and negatively impact your credit score, thus increasing your over all cost of borrowing in the first place. TO avoid this black mark, limit your applications to 4 or 5 lenders and apply to them within the same 30 day time period.

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