By: Reyna Gobel
Private student loans are wrongly considered inferior to Parent and Graduate Plus loans. If you’re thinking about acquiring private student loan debt, you’ll need to know which rumors you’ve heard are and aren’t true about private student loans.
We bust 7 of the biggest private loan myths below:
Myth: You can borrow more than you can afford to repay.
Decades ago, private student loans would advertise availability for seemingly limitless funds for everything from tuition and fees to spring break trips. Some lenders created their own myth.
Fact: Private Student Loan Limits Are Based on Your Finances
Private student loans are now similar to mortgages and car loans in that the maximum amount you can borrow is based on a debt-to-income ratio in addition to your credit score. While that doesn’t mean you should borrow as much as the lender offers, it does mean you aren’t automatically eligible for an amount that is well beyond what you could reasonably payback.
With perfect credit and sky-high income, you wouldn’t be able to borrow more than the college’s total cost of attendance stated minus scholarships and other financial aid received.
Ironically, federal parent PLUS loans are the opposite. Borrowing limits aren’t based on your income at all. The only factor is the cost of attendance minus other financial aid received. A parent who makes $25,000 per year could theoretically be eligible to borrow upwards of $100,000 over the course of four years.
Note: Federal student loans issued directly to students do have reasonable borrowing limits.
Myth: All private loans have higher interest rates than federal student loans.
This myth comes from the fact that federal subsidized and unsubsidized loans issued directly to undergraduate students generally have lower rates than private student loans.
Fact: Federal parent PLUS loans may have higher interest rates than private student loans.
If you have excellent credit, private student loans may have interest rates much lower than Parent PLUS loans. I’ve seen cases of a 2 percent difference. However, parent PLUS loans may be a better option interest rate and otherwise if your credit isn’t so great. We recommend if you get parent PLUS loans this year, you work to improve your credit to open up private student loan options for next year’s borrowing.
Three easy ways to improve your credit rating quickly are to pay down credit card debt, challenge credit report errors, and don’t open new credit cards within 3 to 6 months of when you’ll apply for new student loans. When paying down your credit cards, start by paying down your lowest credit limit card first to have the most impact on your score. Pull your credit reports for free at annualcreditreport.com to check for errors and dispute them online. Only open a new credit card within 6 months of getting a new loan if you don’t have one and need to start building or rebuilding credit.
Myth: Co-Signing for your student has minimal financial consequences.
The myth is that it’s always better to have your student borrow the loan under their name and then you co-sign. The result is minimal responsibility and financial consequences for you.
Fact: If you decide to have your student borrow the loan, you are still financially responsible for the loan.
Co-signers have the same on paper responsibility for repaying student loans as the primary borrower. Your credit report will show the amount and payment history. The lender may consider your income when deciding whether to give a student a temporary break from payments due to financial hardship.
If you decide to borrow more than what you believe your student can repay based on future income, consider taking out the amount you want to and can repay as a private parent student loan. You may get a better interest rate and clear up who’s responsible, which helps avoids family conflict later on.
Myth: The person who pays the loan gets the tax benefits.
Parents or students often think if they are the ones making the payment, they’ll qualify for the student loan tax deduction.
Fact: The primary person on a loan can claim the tax deduction.
The IRS student loan interest deduction requires student loans are issued in the person’s name or to a dependent. If your student or graduate is no longer a dependent for tax purposes, you won’t get the tax benefit that can be worth over $600.
Losing tax benefits is one of the many reasons to take out the loan in your own name if you plan on paying it off.
Myth: Only federal student loan borrowers are eligible for tax benefits.
This myth is based on the idea that federal student loans generally qualify for more federal benefits than private student loans.
Fact: Private and federal student loan interest can be claimed on IRS tax returns.
The federal government doesn’t differentiate between private and federal student interest when applying for the student loan interest deduction. Not going above the income limit does matter.
Currently, the income limit to claim the full $2,500 deduction is a modified adjusted income (MAGI) of $70,000 or $140,000 for a married couple filing jointly. MAGI is your adjusted gross income on your tax return adding back a few deductions such as retirement contributions.
It’s possible to claim a partial deduction with an income between $70,000 and $85,000 or between $140,000 and $170,000 if filing a joint return. For instance, a single filer making $77,250 who paid $2,500 in student loan interest can claim $1,250 (half the maximum amount).
Myth: There are no options for temporary payment breaks if you hit an economic snag.
This myth comes from the knowledge that federal student loans offer income-driven repayment plans and temporary breaks for specific situations such as economic hardship.
Fact: Private student loan lenders offer a wide variety of temporary payment breaks.
Private lenders offer specific breaks from making payments for situations such as unemployment and being within 6 months of graduation. The difference between federal and private loans is that federal student loans have standard guaranteed payment breaks.
Private loan lenders each set their own rules. For instance, one could offer 12 months of payment breaks while another offers 24 months. One may have a specific one just for unemployment, while another doesn’t. When comparing loans, find out the rules from the lender if you don’t have enough in savings to cover loan payments in a financial emergency.
When needed, you can also talk about different repayment plans, too.
Myth: Parents can never be released from co-signer responsibility.
When parents co-sign loans for their students, they are as legally obligated to repay the loan as the student is. If student loans worked the same way as car loans, the only way to get released from the obligation would be to refinance the loan.
Fact: Private student loan lenders build in co-sign release rules into lending agreements.
Lenders generally add into the lending agreement a time frame and process for co-signers to get released from their obligation. The general rule is the student making between 12 to 24 months of on-time payment and proving ability to repay the loan on their own based on credit scores and income. .
The fact that income is a factor in the parent or other co-signer getting released is one more reason that borrowing should be based on a realistic estimate of a student’s future income. On campus career offices and salary.com can provide estimates. Professional organizations in the student’s field are also a great resource and have the added bonus of networking opportunities.