ALTERNATIVE LOANS
What is an alternative loan?
Why would someone borrow through an alternative loan when the interest rates from the U.S. Department of Education are so low?
How are these loans different from student loans from the U.S. Department of Education?
What factors should be considered when borrowing?
The right loan depends on individual circumstances and plans for repayment.
Federal Aid First: Federal Student Aid Frequently Asked Questions
What is an alternative loan?
Alternative loans are non-federal educational loans normally provided by private lenders who require a credit evaluation before approval.
Why would someone borrow through an alternative loan program when the interest rates from the U.S. Department of Education are so low?
Federal loan amounts have had limited increases over 25 years, but the cost of higher education has continued to increase. As a result, some students look to alternative loans to supplement their Federal student loans and other financial aid.
Some students may have reached their aggregate loan maximums in the Federal student loan programs and turn to alternative loans to meet their educational costs.
There are students who are not eligible for Federal student loans: students who have not made satisfactory academic progress or international students.
There are families who do not want to complete the Free Application for Federal
Student Aid (FAFSA) and use alternative loans as a means to meet higher education costs.
How are these loans different from student loans from the U.S. Department of Education?
Alternative loans are funded strictly through private sources and receive no funding from the Federal government.
While alternative loans are considered educational loans, they are not eligible for loan consolidation with Federal Stafford or Federal Perkins Loans. The student who borrows from both the Federal Stafford and alternative loans will have at least two monthly payments upon entering repayment.
Students who borrow from alternative loans do not need to complete a Free Application for Federal Student Aid (FAFSA) and loan limits are not tied to academic status attained (e.g. freshman, sophomore, junior or senior.) Their own creditworthiness and the creditworthiness of their co-signers/borrowers limit students’ borrowing maximums.
Federal student loans and alternative loans are alike in that borrowing is limited to cost of attendance minus any other financial aid or resource. As educational loans, interest paid on alternative loans may qualify for student loan interest as a tax deduction (like Federal student loans). Please see your tax advisor for details.
What factors should be considered when borrowing?
The answer to this question is more complex than someone would think. Some of the factors to keep in mind are:
- Interest rate: Many alternative loans have a variable interest rate that is tied to the prime rate with an additional charge added. For example, a prime rate that is 6.5% may have .5%, 1.0%, 1.5% or 2.0% added to the prime base for a variable interest rate of 7.0%, 7.5%, 8.0% or 8.5%. You should be aware of the current prime interest rate and recent interest trends. Some lenders have a below prime interest rate for select borrowers and coborrowers.
There are also loans that have a fixed rate of interest.
- Loan fees: Loans may have an origination fee which is a percentage of your loan that is deducted from your loan proceeds or added to the total amount that you borrow. Some lenders do not charge an original fee to any borrower and others do not charge one to those borrowers with the best credit rating.
Some lenders also charge a repayment fee that is added to your loan balance when you enter repayment. A repayment fee is normally the balance of your loan plus any accrued interest.
- Co-borrower/Co-signer: Some lenders will offer a lower interest rate and lower fees to a creditworthy borrower who also has a co-borrower/signer. Co-borrowers/signers will probably be required for students who have not established a credit history or may have a less than perfect credit record.
- Repayment flexibility: Lenders may require entering a monthly repayment for both principal and interest or payment of interest on a monthly or quarterly basis. Lenders may also allow deferment of all payments until graduation. While the loan payments may be deferred, unpaid interest will accumulate.
- Frequency of capitalization on accrued interest: Students electing to defer all payments on their alternative loans will have accrued interest to repay in addition to their original loan principal.
Interest that is capitalized frequently, e.g. monthly or quarterly, will cost the borrower more than interest that is capitalized once before entering repayment. Frequent capitalization of interest compounds the interest charged.
- Approval rate: Lenders with low approval rates may have attractive terms for borrowing but may have credit requirements that are difficult to meet.
- Service: Are applications available for online processing?
- Once approved, how quickly are fund transfers sent to the school?
- Is there a toll-free telephone number to contact the lender if the borrower has questions or concerns?
The right loan depends on individual circumstances and plans for repayment.
Below are two examples that illustrate how different student circumstances and plans make a big difference in the costs of borrowing.
Case One: Assume that a student will borrow $10,000, will be in deferment for one year and will have a 15-year repayment term.
Loan One
Origination fee 8% | Principal at repayment | $10,500 |
Interest rate 5% | Monthly payment | $ 83 |
| Total interest/fees paid | $ 6,084 |
Loan Two
Origination fee 0% | Principal at repayment | $10,800 |
Interest rate 8% | Monthly payment | $ 103 |
| Total interest/fees paid | $ 8,578 |
With a monthly payment for 15 years, Loan One is the better choice because the
lower interest rate becomes a more important factor than no origination fees.
Case Two: Assume that a student will borrow $10,000, will be in deferment for
one year and will paid off the loan at graduation.
Loan One
Origination fee 8% | Principal at repayment | $10,500 |
Interest rate 5% | Monthly payment | N/A |
| Total interest/fees paid | $ 1,300 |
Loan Two
Origination fee 0% | Principal at repayment | $10,800 |
Interest rate 8% | Monthly payment | N/A |
| Total interest/fees paid | $ 800 |
With a quick repayment of funds, the loan without the origination fee is the less expensive option.
The best way to determine what loan is right for you and what your overall loans would be is to analyze the components of your loan. There is a handy tool on the www.finaid.org Web site called the Loan Discount Analyzer at http://www.finaid.org/calculators/loandiscountanalyzer.phtml. The Loan Discount Analyzer will help you determine the costs of your loan. By taking the time to obtain more information, you can make a better choice of loan products and be a more savvy consumer.
Sample List of Alternative Loan Providers
Students and their families are able to find many loan providers who participate in alternative loan programs. In fact, there are so many providers with so many products that it is easy to be confused. To help our students, the Office of Financial Aid is providing a list of alternative loan providers that have been used by our students. While there are many attractive loan products with responsible lenders, the Office of Financial Aid has based its selection on our experience with loan providers who offer attractive terms and have a history of good service with our students. Students should be a smart consumer and research loan providers and select the one that best meets their needs.
You may obtain more information about each lender and their products by linking to their Web sites.
- Federal Direct PLUS Loan and Grad PLUS loan (administered by the University of Michigan-Dearborn for the U.S. Department of Education)
The Office of Financial Aid encourages students who are eligible to apply for the Federal Stafford Loan Program by completing a Free Application for Federal Student Aid (FAFSA) before considering alternative loans. If you have concerns about whether or not you are eligible for a Federal Direct Loan, please contact the Office of Financial Aid with your questions.
Alternative loans can provide important supplemental or primary funding for students. It is also important to remember that an informed consumer may be able to reduce the amount of interest and fees paid through a careful matching of loan product and student needs.
Students choosing alternative or private loans are free to select a loan product that best suits their needs.
