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More college students are making this major loan mistake

The Motley Fool logo The Motley Fool 8/10/2018 Maurie Backman

With countless students nationwide packing their bags and gearing up to head off to college, a large number of future graduates are no doubt feeling the financial crunch. In fact, some students might be scrambling to fund their upcoming studies, thereby increasing their likelihood of falling victim to a growingly dangerous trend: borrowing for college from private lenders.

According to data from, students are becoming increasingly reliant on private loans to cover their various costs. In 2018, the average private student loan balance was $18,332, compared to $16,078 in 2017 and $14,446 in 2016. And the reason largely boils down to the fact that the cost of most U.S. colleges exceeds the current limits for federal loans.

Though college costs have increasingly risen over the past decade, federal student loan limits have not gone up since 2008. So, when students find themselves unable to cover their costs even after maxing out their federal borrowing options, they often turn to private lenders as a last but necessary resort. In doing so, though, they make it much harder to manage their loan payments once they start coming due.

The dangers of private student loans

Any time you borrow money, you automatically sign up to pay more than the original loan amount taken out. That's just how loans work. However, whereas federal loan interest rates are regulated, private loan interest rates are not. As such, you may come to find that you're paying a substantially higher interest rate on a private loan than a federal loan, thereby making it costlier. Furthermore, when you take out federal loans, you lock yourself into a fixed rate for the duration of your repayment period. Private loans, though, often come with variable interest rates that can rise over time, thereby making your monthly payments even more burdensome.

Another issue with private loans is that they pretty much offer zero protections for borrowers. If you take out federal loans and lose your job, you can ask to defer your payments until you're back on your feet. Similarly, you can apply for an income-based repayment plan if your standard repayment plan (10 years for federal loans) results in a monthly payment that's too onerous. With private loans, you're at the mercy of your lender, who is by no means obligated to cut you any slack, regardless of whatever financial hardships life throws your way.

Finally, unlike federal loans, private loans don't come with a borrowing cap, which means you could conceivably rack up as much debt as you'd like. And that's a dangerous road to go down when you're young and relatively unaware of just how difficult it can be to pay that money back.

A better way to pay for college

If the cost of attending college exceeds the amount you're eligible for in federal loans, there are several avenues you might explore before resorting to private lenders. For one thing, you can see about transferring to a less expensive school. Based on current average tuition costs, switching from a private university to an in-state, four-year public college could save you roughly $25,000 a year.

If that's not an option, try working as you go to pay your tuition bills rather than finance them all. You might even look into taking a semester or two off to save up some money. Or, do the opposite -- accelerate your studies so that you graduate a semester or two early, which will shave a bundle off your total costs as well.

In a perhaps more ideal world, federal borrowing limits would better align with the costs students are facing today. Then again, those borrowing caps exist for a reason -- to prevent students from getting in over their heads. So, if you've maxed out your federal loans, don't be so quick to turn to private lenders. Chances are, it'll be one of the costliest mistakes you ever make in your lifetime.

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