How Does a Private Student Loan Work?
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A private student loan is an education loan from a private bank or financial institution. This is different from federal government-supported loans such as Stafford or PLUS loans or loans supported by state governments. Since private loans are provided by companies that are private entities and are out to make a profit, they are generally more expensive, with higher interest rates.
Financial Aid Application
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When students are admitted to an institution of higher education for undergraduate, graduate or professional study, most students fill out a Free Application for Federal Student Aid (FAFSA). This application goes to the government agency that administers federal student aid. Each student's financial situation is analyzed and the student is offered an aid package that could be a combination of grants, work study, and federal loans.
When the financial package awarded a student still does not cover the cost of education and the student has no other recourse, he turns to private student loans.
In other instances some students, such as international students or students whose families are more well off financially and are therefore expected to make a more significant contribution to the student's education, would not qualify for financial aid. Those students also resort to private student loans.
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Private Student Loan Application and Acceptance
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If getting a private student loan is your only option after all attempts to get other kinds of financial aid have been exhausted, the first thing to do is to shop for a good loan with a good rate that would cost you the least over the life of the loan. The key to getting the best deal is a good credit history and rating.
When shopping for loans look out for the rates. Most private loan interest rates are pegged to the LIBOR rate (London Interbank Offer Rate--the rate at which banks lend unsecured funds to each other in the London wholesale money market). Others peg their rates to the Prime rate (PRIME). The best student loan deals are those closest to the Federal PLUS loan, with an interest rate of LIBOR plus 2 percent or PRIME minus 0.5 percent without fees. (See Resources below for a link to a private student loan comparison table.)
In some cases if a borrower's credit rating is not good enough, he may need a co-signer. Some loans require a co-signer because of the age of the borrower or if the borrower is an international student.
Once a loan application is accepted and a loan is approved, the student borrower and the co-signer will have to sign a promissory note.
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