Understanding the Costs of Using Private Student Loans to Finance College

College aid programs, including scholarships and federal Stafford loans may cover a portion of the costs, but they cannot cover them all. Therefore, many students are now turning to private student loans to make up the difference.

There are plenty of lenders out there who are more than happy to lend you the money. Incentives and ad displays promising you all the money you need without having to pay anything until after graduation is one way that lenders lure borrowers.

This sounds enticing, but are you certain that you understand the long-term costs with that decision?

Let’s run through an example:

Say that you borrow $12,000 for the year that includes your origination fee.

You use the money to pay any expenses not covered by your financial aid package.  Likewise, you choose to defer repayments until 180 days after graduation.

The interest rate on private student loans is variable

meaning it can go up or down each month while you are in school and when you are in repayment.

For this illustration, let’s say the rate stays constant at 7% for the next 48 months (the 4 years that you are in school):

• Loan amount borrowed: $12,000
• Annual interest rate: 7.0%
• Deferment period: 54 months (includes 180 days after graduation)

By the time you graduate (with an 180 day deferment), the total amount of your loan will be approximately $15,780

which includes the original loan amount and the interest charges accumulated during the deferment period.

Now, let’s assume that you borrow the same amount to pay tuition, housing, books, etc., again in your 2nd, 3rd, and 4th years in school:

• Sophomore Year: $12,000 borrowed
• Junior Year: $12,000 borrowed
• Senior Year: $12,000 borrowed

You have now graduated from college. You will have 180 days after graduation before you make the first payment.

The repayment terms will be as follows assuming the interest rate was constant:

• Loan Amount: $58,080 (this is the approximate amount of money borrowed over the academic years that includes the amount of interest charges during your deferment period).
• Interest Rate: 7% (this is a variable rate that can change monthly. For this purpose, we will keep the interest rate constant).
• Term: 240 months (you will have 20 years to repay the loan).
• Monthly Payment: approximately $450.29

That is a big monthly amount to make each month.

But it may be okay considering the type of job you are able to get with your college degree, which can pay a lot more money per year than jobs not requiring a degree.

Consider student lending as an investment into a great career. However, you need to understand the cost-benefits analysis using private student loans to finance your college.

Now let's consider the costs if you were to borrow the full amount to pay the total cost of education

If the cost of education was $30,000 and you borrowed that full amount each year with deferred payments, your repayment structure would look like this:

• Total amount borrowed including interest rate charges during deferment: $145,200
• Your monthly repayment during 240 months with interest rate being constant: $1,125.73

If your cost of education was $40,000 and you borrowed the full amount each year with deferred payments

your repayment structure would like this:

• Total amount borrowed including interest rate charges during deferment: $193,600
• Monthly repayments for 240 months with interest rate being constant: $1,500.98

So be careful on the total amount that you will borrow.

Only borrow the amount you need to cover the cost of education minus other college financial aid that you may receive. 

Also use our budgeting worksheet to plan your education costs. It can be a useful tool to help you keep higher education costs down.

Also note that upon graduation, you will receive a $300 principal reduction on each loan as a gift (proof of graduation will be required).

In the example above, with a loan taken out each four years, you will receive a $1,200 principal reduction with proof of graduation! : ⁴

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Notes:

1 Undergraduates and graduates usually can defer repayments until six months after graduation or ceasing to be enrolled at least half-time. Immediate and interest only repayment options may also be available.

2 Be sure to ask about the origination fees charged by the lender. Origination fees can add to the cost of your loan. Some lenders may have zero origination fees but charge a repayment fee. So make sure you read the fine print before applying.

3 Graduation gifts may include cash awards or rate reductions. Compare benefits among lenders.

4 Most rate reductions are available to borrowers who arrange to automatically deduct monthly payments from their bank account.

5 Borrowers must meet credit guidelines at the time the cosigner release is requested.

6 Student must be the legal age of majority or at least 17 years of age with a Cosigner who is legal age of majority. The legal age for entering into contracts (the age of majority) is 18 years of age in every state in the United States except the following:  Alabama and Nebraska 19 years old, and Mississippi and Puerto Rico 21 years old.