Why You Shouldn’t Take Out Private Student Loans

sad dog representing why you shouldn't take out private student loans

I just can’t do it. This post was supposed to be on what you need to know about taking out private student loans. I researched all the ways that private loans differ from federal student loans. You don’t need to go past the first page of a Google search to find all the comparisons which pretty much say the same thing. They all conclude that federal loans are the better option.

The problem is that most people who are looking for private loans are doing so because the federal loans aren’t enough to cover their college costs. So students turn to private loans to make up the difference. And apparently parents are ok with this since they are co-signing the loans. Most students don’t have the credit rating to qualify for private loans otherwise.

So why am I not writing about the issues families need to be aware when taking out student loans? Because I have yet to see any justification for taking out private loans for a freshman.

Graduates grateful for taking out large student loans

I actually came across an article from Forbes that interviewed two students who took out more than $50,000 in debt for college. In some ways, the two students sound like they made reasonable choices. They made sure they graduated in four years and took advantage of every opportunity to ensure they had jobs when they graduated. The interesting thing is that while the article tells us how much they borrowed, it never says how much they are earning in their jobs.

Another article I found talked about her $50,000 debt and that she thinks it was worth it. And she doesn’t even bother with Return On Investment (ROI) argument. But I guess it’s a great way to start a career writing about personal finance.

Before I go any further, I want to make clear that I’m not against students taking out Federal Direct student loans. These are designed to limit students to a reasonable amount of debt and have a variety of repayment options. What I think is a bad idea is when people turn to private loans to borrow more than the amount allowed under the Federal program.

As Mark Kantrowitz nicely puts it “Needing to borrow a private student loan or Federal PLUS loan may be a sign of over-borrowing.” If you want to know anything about private student loans, I suggest you just visit his website Private Student Loans Guru. It has everything you could possibly want to know about private student loans.

Why students consider private loans

It seems that students and parents start considering private loans in two situations. The first I find heartbreaking. The student has been accepted at their public state university and even with federal aid, the family doesn’t have the resources to cover the remaining costs. Take a look at what the average net price is for families with the lowest income category for you state public schools and you’ll realize how common this is.

It’s tempting to tell them to go ahead and borrow the extra five to ten thousand a year so that the student can attend the college full-time. All the data indicates that students are much more likely to graduate if they can start full-time at a four-year institution as oppose to a community college. However, this assumes that the four-year has a decent graduation rate.

The second situation is where a student has decided on a major that isn’t offered at his in-state public universities. Or in some cases, they don’t have a great reputation for the major. So they decide to go to a private school or an out-of-state public university which is supposed to be great for the major.

Students change majors

I have three problems with this justification. The first is that the vast majority of students change their major at least once in college, if not two or three times. They may find out they aren’t any good at it, that it bores them, or that they’re actually much better at something else.

We did a college visit with my son when he was going through the admissions process. During the parent presentation, the speaker asked how many of the 100 or so parents in the room where working in the field they had initially majored in. Two people raised their hands, my husband, a pharmacist, and an engineer.

The private student loan could lead to an incredibly fulfilling career. Or it could cause the student to spend her life in a profession she hates just to pay back loans based on a decision she made when she was 17.

What is your proof of ROI

The second problem is the belief that the more expensive program is better than the cheaper alternative. How exactly are families deciding this? Please don’t tell me US News Best College Rankings. Before you invest an extra $50,000 a year, please tell me that you’ve at least talked to a variety of professionals in the field. How hard is it to call the alumni association of the “questionable” program and asked to speak to some graduates about their experiences?

And the final problem is that despite the student’s certainty of their major and the value of the program, few seem to have actually sat down and used a student loan calculator. They don’t have any idea of what they’re monthly payments will be.

Some do but haven’t considered them in the context of all the other living expenses they’ll have. They don’t know if they the payment is higher or lower than their likely rent. Nor have they taken the time to research their chosen profession’s outlook and likely salaries by city. But they are absolutely certain that they know they have to attend a specific school or they’ll never succeed otherwise.

Freshman should not be taking out private loans

This basically comes down to that I think people are making a huge mistake when taking out private loans as freshman. I can see where someone may take out a loan as a junior or senior so that they can graduate. It’s not a great situation but after all, the only thing worse than having student debt is having debt and no degree.

However, I think that in 99% of situations if a freshman can’t afford a college without taking out a private student loan then the fact is simply she can’t afford the college. In most cases, freshman are making a serious financial mistake, unfortunately aided by their co-signers, when taking out private student loans to pay for a preferred alternative college.

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