Personal Loans

What Is One Reason Why Private Loans Are Less Favorable

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 15 minute read

At the present time, most American students cannot afford to attend college without taking out a student loan. Indeed, a 2019 research from the Institute for College Access and Success found that 68% of students who borrowed money to pay for college did so in 2018.

That’s due to tuition prices increasing at a far quicker rate than average family incomes. The College Board has been collecting data on the cost of attending public and private colleges and universities since 1971, and their findings have been reported by CNBC to show that the average overall cost of attendance has more than doubled in that time. 

You may get the entire spreadsheet from the College Board’s website. However, middle-class salaries have not increased. It’s no surprise that borrowing has become so popular.

The Student Loan Reality

The average family’s income has not increased as quickly as tuition prices have. This is illustrated by the fact that the average annual cost of attendance at a public, four-year institution was $8,890 when the College Board first began tracking such data. 

According to data provided by the Pew Research Center, that amounted to over 18% of the typical family income of $50,200 at the time. A whopping 47% more money was made by the average American family in 2018, bringing the median household income up to $74,600. 

Public university tuition and fees, however, increased by 145%, to a yearly total of $21,790. As a result, the price of higher education now consumes more than a third, rather than less than a fifth, of the median family’s yearly income.

Because of this, the great majority of students require financial assistance in the form of student loans. It gets worse even while most federal loans with the exception of Parent Plus loans don’t require a credit check and, thus, no co-signer, they may still fall short of covering a student’s whole cost of attendance when added to other forms of financial help. 

But this is a much bigger issue for undergraduates than it is for graduate and professional students, who can take advantage of Grad Plus loans to cover their full tuition with no additional repayment required.

Because of this, many students end up needing more funding, which is when they may consider applying for private student loans, which may require a co-signer.

Why Students Need a Co-Signed Document

For the most part, students in their early twenties are not yet established financially. However, this is not an issue when applying for federal student loans, which are the most popular method of financing higher education in the United States.

Private loans through a company like LendKey may be necessary when a student’s financial need exceeds the total amount of aid available, including grants, scholarships, federal loans, state loans, institutional loans, and work-study. Plus, these need to run a credit report. 

Therefore, a co-signer may be required for a student who either does not have a credit history, has a poor credit history, or does not earn enough money to meet the income requirements alone.

If your savings and government aid falls short, a private loan may be an option. But there are major downsides to them. Make sure the borrower is aware of the drawbacks of private student loans compared to federal student loans before you agree to co-sign for the loan. 

Unlike federal loans, the interest rate on a private loan can be as high as the borrower is able to afford. Government debt repayment schemes are one example of a repayment option that borrowers would not have access to. 

Additionally, if they run into financial trouble or have trouble finding work after graduation, they will have few choices for postponement or forbearance. Private loans should be the last alternative for students because of these factors. 

Be sure you and the student have exhausted all other avenues for covering college costs, such as working part-time, before settling on a PLUS loan. 

If you are a parent thinking about cosigning an undergraduate loan, you should know that you have the option of applying for a federal Parent Plus loan in your own name to help pay for educational expenses not covered by your child’s financial aid. 

You’ll discover that the Parent Plus loan’s repayment terms aren’t quite as flexible as those of other federal direct loans, but they’re still much better than those of private student loans if you ever find yourself in need of them. 

Even if you take out the loan in your child’s name, you and your child might agree that your child is liable for repayment. You will still be held financially accountable for the Parent Plus loan even if they do not return it, but the loan will have better terms and repayment choices.

If a private loan is still your sole option, weigh the benefits and drawbacks for both you and the student borrower very carefully before signing any paperwork.

Risks Associated with Co-Signing a Private Student Loan

Risk is inherent in co-signing any loan, as you will share the debt with the borrower. Cosigning a private student loan is riskier than cosigning a federal student loan because the law handles federal and private student loans differently. The emotional fallout may also cause problems in the home.

1. The Loan Is Your Responsibility.

If you put your name on a loan application alongside the borrower’s, you are just as responsible for paying it back as the borrower is. That puts the burden of payment on you if the borrower defaults on their loan. What this implies is that if the borrower is late with payments or unable to pay, it will reflect poorly on your credit report. Overdue payments put you at risk of legal action to recover the money you borrowed.

Even though it may seem more prudent to put a student loan in the name of the student, who would be the one to repay it, a Parent Plus loan might be advantageous in some situations. Borrowing the money yourself gives you the most flexibility in terms of how and when payments are made, even if that wasn’t your original intention.

2. It Needs a Long-Term Commitment

Taking advantage of deferments, forbearances, or interest-only payment periods can extend private loan terms to over 10 years, which is longer than what the government offers. Therefore, it is not unheard of for repayment to take up to 20 years.

In addition, co-signers are seldom released and often mistreated, despite the fact that some lenders have plans to dismiss the co-signer when the borrower makes a specific number of on-time payments. 

One of the many reasons the Consumer Financial Protection Bureau sued Navient, a government and private loan servicer, in 2017, according to The New York Times. Nonetheless, the resolution of that litigation has been delayed for years, leaving debtors in limbo.

3. Family Discord Can Result.

In any way that we can, we wish to support our children. But the stress and unease that comes with taking on a long-term loan can put a dent in even the strongest of bonds. Your inability to sleep could be a direct result of the amount of money you co-signed for, since you may be concerned about your child’s ability to keep up with payments. 

But if they end up unable to pay back the loan, you may learn to detest your own offspring and deeply regret signing the document.

4. Interest Rates Are Not Restricted by Law

Interest rates on government student loans are capped by law, but private lenders are not subject to these restrictions. The greatest rates, especially for the most creditworthy consumers, are something that banks strive to give in order to remain competitive with one another. 

However, the interest rates on these loans are usually higher than the rates offered by the federal government. That’s with the lone exclusion of refinancing loans. However, you won’t have access to them until graduation, and even then, only if your credit is really stellar.

Before the government issued Grad Plus loans, for instance, I financed my first two years of graduate school with private loans. The private loan interest rate is currently double that of my federal loan interest rates (including the Grad Plus loans I took out for the subsequent two years).

In addition, like credit card companies, lenders can increase rates for overdue payments. Furthermore, the rates are frequently flexible, meaning they change as the market dictates. 

A higher rate is possible regardless of the borrower’s efforts. What’s more, you’ll be responsible for the entire loan’s repayment if the borrower messes up in any way, such as by failing to make payments or going into default.

5. Interest Accumulation Begins Right Away

Private student loans, in contrast to federally subsidized loans, begin charging interest the moment they are disbursed. When the borrower graduates and the grace period for making payments ends, the interest capitalizes or is added to the principal debt. 

They will wind up paying interest on top of interest, as the interest they initially paid will now be applied to a larger sum.

What you just described also occurs with federal unsubsidized loans. This is important since the amount you end up owing on the loan you cosigned for could balloon by the time the student graduates.

6. Student Loan Forgiveness via Private Lenders

Students who take out large loans (say, $100,000 or more) may find the income-driven repayment program’s option to have their loans are forgiven after 10, 20, or 25 years of payments very helpful, especially if they go into low-paying public service fields like teaching, social work, public defense, or public health. 

After 10 years of making payments on a federal loan, borrowers who are employed full-time in certain public service occupations, such as teaching, public health, social work, or public defense, are eligible to receive public service loan forgiveness, which releases them from any further repayment obligations on the loan.

Moreover, while certain employers may offer student loan repayment assistance (which can be applied to any type of student loan), private lenders never provide loan forgiveness options. Until one of you repays the loan in full, you’ll both be saddled with it.

7. It Might Damage Your Credit

Co-name signers will appear on both the co-signer and the borrower’s credit reports, as stated by Experian, one of the three major credit reporting bureaus. This means that the borrower’s FICO score will suffer as a result, even if the borrower is diligent about making payments on schedule.

Worse, if the borrower is late with payments, that will reflect poorly on your own credit report. To add insult to injury, a low credit score might make it difficult to secure financing for essential purchases like a new automobile, a home improvement project, or a credit card. 

Your interest rates on any loans you currently have may increase, and you may even be prevented from getting a new job altogether.

8. Options for Economic Hardship Are Limited

When it comes to deferment and forbearance choices, private lenders are significantly less accommodating than the federal government. The borrower is still responsible for paying their private student loan each month, even if they lose their employment through no fault of their own. 

It’s impossible to know what may happen in the future, and this is especially true when taking out a loan with such a lengthy repayment period. The borrower will be in a hopeless situation if they lose their job and can’t pay their bills. That’s bad news since it indicates it’s headed your way.

9. The Borrower Might Not Be Able to Pay

The reality is that some graduates have trouble finding work, even if they are the smartest and most popular students in their classes. Those who do have jobs are generally underpaid. 

The Federal Reserve Bank of New York reports that as of June 2020, 39% of recent college graduates are underemployed. Worse, it’s impossible to predict how long this will continue.

So, while deferment or forbearance may help in the short term, they may require a more permanent solution, such as the income-based repayment plans available for federal loans. 

However, there is no equivalent option available from private lenders. What this means is that you will be responsible for making the loan payments in the event that the borrower is unable to do so for an extended length of time.

10. Student Loans Are Not Forgiven in Bankruptcy.

Borrowers often consider bankruptcy as a viable option if they find themselves unable to repay their debts. But in bankruptcy, not all obligations are equal. The federal government and commercial lenders both consider student loans to be priority debts. 

That implies they cannot be eliminated in a bankruptcy proceeding and will have to be paid in full. Discharging student loans technically requires meeting an undue hardship standard. Nonetheless, the bar is set so high that passing the test is next to impossible. 

To qualify for bankruptcy protection under the Hartman Bankruptcy Act, a debtor must demonstrate that (1) paying back the loans would result in an absolutely insupportable reduction in living standards for the debtor and his or her dependents, and (2) the debtor has no reasonable expectation of being able to repay the loans at any time in the foreseeable future. Rarely do borrowers pass this requirement?

However, if you co-sign a loan, the court will also consider your financial stability while making a decision on whether or not to discharge the loan, making it much more difficult for the borrower to get rid of their student debt. Moreover, the lender may pursue you if the borrower ever files for bankruptcy.

11. They Hire Less Generous Default Terms

If you take out a private student loan and end up unable to make the payments, you’re in a world of hurt. Lenders often offer fewer repayment options, such as forbearance and deferment, than do federal loan providers, and bankruptcy is not an option. Default terms for private lenders are typically much shorter, which is a major drawback.

The grace period for federal student loans is 270 days or about nine months. After that, the loan is considered to be in default. If you are in default, you no longer have any time to make payments until the entire loan balance is due. However, if you have a federal loan, you may be able to get out of default by consolidating or rehabilitating your debt.

Private student loans are not like this at all. Default is defined differently by private lenders, who may consider a debt to be delinquent after as little as one day past due. While most private lenders will allow you at least 30 days to pay them back, nine months is quite unusual. 

That implies the lender can refer the entire debt to a collection agency and even commence legal actions to recover the amount outstanding if the borrower misses a single payment. Because of the fact that your name is on the loan, the creditor might also go after you.

12. You Might Be Subject to Debt Recovery

Debt collectors are persistent in their pursuit of you and their use of both written and verbal harassment to try and get what they’re owed from you. If the debt isn’t even legally yours, it might be very unsettling. Learn your rights in case something like this occurs to you.

A debt collector is prohibited from doing the following by the Fair Debt Collection Practices Act:

  • If you don’t hear from us by 8 a.m. or 9 p.m
  • Even if you’ve told them you can’t be reached at work, they should try calling there nevertheless.
  • You should talk to someone outside yourself or your partner about the debt (unless you hire an attorney, in which case they must speak only with your attorney unless they fail to respond within a certain time frame)
  • Repeatedly calling you only to bother you is one form of harassment, as is using profanity or obscene language, as well as threats of physical damage.
  • Misrepresent your debt, that you’ll be arrested, or that legal action will be done against you when you don’t.
  • Add interest and other fees to the debt unless prohibited by law or the terms of the transaction.
  • Early deposit of a postdated check
  • Unless they have the right to do so, no one can seize your property or threaten to do so.

You should keep track of any occasions in which the debt collector fails to comply with these, as doing so could provide you grounds to file a countersuit if the debt collector decides to sue you to collect on the loan.

You can also tell the debt collector over the phone that they can only contact you in writing if you want the phone calls to stop. In fact, that should be the norm in general, as sharing private information over the phone is never a good idea. Scam phone calls are unfortunately commonplace today, and there is no foolproof way to tell if a caller is authentic.

On the other hand, you might write a cease and desist letter to the debt collector, telling them to halt all further communication with you. It is prohibited for a collection agency to continue contacting you after you have requested that they cease such contact via letter or verbal request. If you need advice on the law, it’s best to talk to a lawyer.

13. Lenders Have the Right to Stealing Your Wages

Private student loan debt has a silver lining in the form of a statute of limitations on collection attempts. Three to ten years is typical, with the average being six years. Visit Nolo for a complete breakdown by state.

The federal government does not place such restrictions on student loans. It’s likely, though, that the lender will try to sue before the statute of limitations runs out if neither you nor the borrower has been making payments.

Garnishment of earnings or Social Security benefits or seizure of tax refunds may result from defaulting on federal student loans, all at the discretion of the U.S. Department of Education (DOE). You would be sued if you tried to do this with a private lender. 

Since you and the borrower have equal responsibility for repaying the loan, both of your earnings can be garnished for the unpaid debt if the lender is successful in obtaining a court order to do so.

If your lender sues you, you must respond to the court documents by the period specified in them. Furthermore, investigate locating an attorney through your state’s bar association or a national search service such as FindLaw.

14. If You or the Borrower Pass Away, They Aren’t Forgiven

Federal student loans, including Parent Plus loans, are forgiven upon the borrower’s or co-death, the borrower provided the DOE is provided with a valid death certificate.

Personal student loans are not like that. This debt will instead become a claimant against your estate. Accidents and diseases are unfortunate realities that no parent wants to face. 

They will leave you with their unpaid student loan debt and a broken heart. If you’re going to be a co-signer on a private student loan, the borrower needs to have adequate life insurance to pay off the balance in the event of your death.

15. It Endangers Your Retirement.

Being prepared to risk your retirement savings to cover the cosigner’s school loans is not a good idea. It’s admirable to want to provide for our kids’ higher education costs, but there are no student loans for old age.

Actually, most financial gurus would tell you to put yourself and your retirement first before worrying about your kids’ college fund. The reason for this is that if you put off investing for your retirement in favor of funding your child’s education, your offspring may end up having to support you financially in old age. Because of this, putting other people first is counterproductive.

Bottom Line

The desire to provide for one’s offspring comes naturally to any parent. However, watch out that you’re not the one who ends up making the wrong decisions. To add to the potential downsides, co-signing a private student loan may not be in either of your best interests.

While most Americans will need to take out some sort of loan to finance their education, private student loans come with some significant drawbacks. These potential consequences may affect both of you if you co-sign for someone. I had to learn this the hard way, unfortunately.

Consequently, you should think carefully about the consequences of co-signing a debt for your child before agreeing to do so. Researchers at ACT, the organization responsible for the ACT test, found in 2019 that the vast majority of freshmen are unprepared for the financial commitments that will be required of them as college freshmen. So, if you’re going to sign legal duties as a family, be sure you all mean it.

Including, perhaps especially, the option to not provide a co-signing signature. If you do make that choice, reassure yourself that there are many other things you can do to help your child afford colleges, such as assisting them in finding alternate loan programs, scholarships, or other forms of financial aid. 

Don’t let anyone bully you into making a decision that could affect your child’s and your financial stability unless you’re ready to accept the possibility that you’ll have to pay for it.

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