Ask Money

A private student loan

Chris Farrell Aug 11, 2011

Question: I heard you denounce private student loans on the show yesterday (8/10/11), saying (a) they should never be used unless federal student loans are exhausted and (b) they are as bad as credit card debt. That was a real surprise, and I hope you can clarify what you mean. I have a private student loan from one semester that I was not eligible for federal loans because I was not technically enrolled in a degree program. I have a 7.55% rate which isn’t much higher than federal student loan rates. I plan to pay it off the quickest of my student loans when I graduate. Am I in a worse financial position than I realize because of this loan? Matt, Williamsburg, VA

Answer: No, you are not in a bad financial situation.

Here’s the thing: Federal student loans have a great deal of flexibility built into them. There are a number of repayment options, you can restructure your debt if you run into a rough earnings patch, and even defer debt payments.

Of course, the price of taking advantage of any of these options is a hike in the total cost of your government student loans. (At least that’s the risk. There is no prepayment penalty with student loans so if your financial circumstances improve you can always pay them off early.)

Private student loan is really a label for a form of consumer debt. It’s much like a credit card, but with a lower interest rate. These consumer loans don’t offer the financial flexibility and options of federal student loans. You have to pay the bill.

Traditionally, the private student loan market was relatively small. Students used them to borrow a limited amount of money to finish a credit or a semester. That was fine. The concern about private student loans has grown as they have become a larger part of the overall market. The more a student loan portfolio is comprised of private student loans the more onerous the debt burden.

In your case, you only have a loan from one semester. You tapped into the market for an old-fashioned reason. I wouldn’t worry about it. I would follow through on your plan to get rid of it first, however.

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