Did you know that Americans owe over $1.64 trillion in student loan debt? According to a recent study, among the class of 2019, almost 70% of college students took out loans to finance their education.
With numbers like this, it’s no surprise that many people express anxiety around their student loans. We’ve written a post to give you a guideline on when to refinance your loan, but you’re probably wondering how they work in the first place.
Not to worry, we have all your basic loan questions covered here, and we’ll explain why interest rates vary between federal and private lenders.
Let’s get started with federal loans.
There are 4 different types of federal direct loans available:
- Direct Subsidized Loans: Eligibility based on financial aid
- Direct Unsubsidized Loans: Eligibility not based on financial aid.
- Direct PLUS Loans: Loans for graduate or professional students, or parents of dependent undergraduate students. Credit check is required, although eligibility is not based on financial aid.
- Direct Consolidation Loans: Enable you to combine federal loans into a single loan.
Note, that with the exception of the Direct PLUS loan’s requirement of a credit check, the eligibility requirements are fairly minimal. This is because, as long as you’re a student, the government has “decided” that it will assist you in your educational journey by providing you with the finances to do so.
This means that pretty much any student gets a loan. As a result, interest rates on federal loans tend to be pretty high.
This is because Interest rates for federal loans are set by Congress, and are based on the treasury rate. It doesn’t matter your credit score or profession – anyone that receives a federal loan will pay the same rate.
Private lenders, on the other hand, set their interest rates based on your creditworthiness. Creditworthiness, simply stated, is your likelihood of failing to pay back your loan, or defaulting
Lenders can take into account a myriad set of factors – including, of course, your credit score – to decide what rate they will lend to you.
In recent years, a handful of new private new technologically-enabled lenders have cropped up, such as SoFi and Earnest. These private lenders are able to offer lower interest rates, because they have built algorithms to assess an individual’s creditworthiness, and only lend to individuals who fit within this profile.
A lot of people have the idea that private lenders are the devil, and I’m here to disavow you of this notion. For the right type of borrower, they can be a great refinancing option. What are the characteristics that determine the “right” person? It really comes down to three things: credit, education, and employment.
The stronger your credit score and history, the more attractive of a candidate you are to private lenders. Your credit score is a complicated thing, and we can devote an entire series of posts this topic. However, for the purpose of student loan borrowing, suffice to say that a higher score helps place you in consideration for lower interest rates.
If you’re still evaluating whether to go to school, use this time and work on improving your credit score, or maintaining it if it’s at a high level. You’ll thank yourself later when it comes time to borrow or refinance.
These days, more and more private lenders are beginning to use new criteria to evaluate the credit-worthiness of their borrowers. One factor that has recently come into play is education. You shouldn’t always be dissuaded by the sticker price attached to top-ranked institutions of higher-learning. Many offer generous scholarships, and depending on your circumstance, can work with you to find a viable solution to finance your education.
If you did receive a degree from a well-regarded institution – now is your time to floss. It can certainly be viewed as an advantage in the eyes of certain lenders.
Much like your credit score, your employment history is a profile that you build over time. It’s something that certain private lenders will look at to evaluate you. If you are still in school and haven’t started working yet, but have a job offer in hand that you’ve accepted, use it! At the very least, you can get an idea of what your refinance rate might look like. Remember, getting a preliminary interest rate estimate from a private student loan provider does not affect your credit score.
Private students tend to get a bad reputation. Hopefully this post has illustrated that not all are created equal. If you have the right type of characteristics – educational background, credit score, and income – you can use this to your advantage and refinance at a favorable rate.
We want to hear from you! Share your student loan questions in the comments below.