Understanding the New Private Student Loans

For decades the federal government has offered loans to students who can't afford to pay for college by themselves. Recently those loans switched from having variable to fixed interest rates. In response, the past few weeks have seen some private banks alter their student lending game. Traditionally purveyors of variable-rate loans, U.S. Bank and Wells Fargo now provide their clients loans with fixed rates as well. What are students (and their families) to make of this?

By Eric Garneau

The Bottom Line

In a move perhaps spurred on by the insecurities and hardships wrought by a fluctuating housing market, two major lending institutions - U.S. Bank and Wells Fargo - have begun to buck the tradition of offering only variable-rate student loans. Starting this June, both companies now provide their customers with fixed-rate loans as well. How much those loans cost depends on the credit of the borrower (or the co-signer, since students rarely have sufficient credit to take out loans themselves).

For both banks, according to The New York Times, those fixed rates aren't really all that competitive with current variable ones. Fixed interest on Wells Fargo loans can run from 7.29% to 14.29%, depending on the applicant's credit and the type of school being attended. U.S. Bank offers loans with only one fixed interest rate, 7.8%. Variable interest rates, in contrast, currently hover around the four percent mark, and The New York Times reports that no significant interest rate increases seem imminent.

Why Choose a Fixed Rate?

One might wonder, then, why customers would opt to go with a fixed rate loan that will almost certainly have them paying more month-to-month. The answer, as you can possibly guess, is security. Students (or their parents) like knowing how much they'll owe each month for the next 15 years. Any sense of risk or gambling is taken out of the equation. Again, that can probably be attributed to the last few years of housing loans, the variable rates of which caused many duress. Early reports from Wells Fargo show that a greater number of families than expected have taken advantage of a fixed-rate loan; clearly, more than a few families value the ability to precisely plan long-term finances.

To Borrow or Not to Borrow

On the other hand, these recent announcements have caused some to reevaluate whether private student loans are worth taking out at all. In the book Debt-Free U, author Zac Bissonnette argues that if you can't cover the cost of your college with saved money plus federal student loans (which currently top off at $31,000) you're in over your head. Besides compounding your debt, private loans are also less forgiving when it comes to making payments. Federal loans offer caps, suspensions and forgiveness for borrowers in various circumstances. Banks may not be so accommodating.

In contrast to Bissonnette, other financial advisers - like Sallie Mae's chief marketing officer Joseph DePaulo - suggest that drawing the line at federal loans is arbitrary. If students need to borrow some money, what makes $31,000 the magical ceiling? It could be that the finances secured with private loans will be what pushes students towards completing their academic goals and landing a fulfilling career. Whatever the case may be, students and their families need to think long and hard about how much money to borrow for an education. Perhaps for some these new fixed-rate loans have made that question a little easier to process.

Read about what some have called a financial crisis in higher education.

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