Are you considering furthering your education by going to graduate school? If so, congratulations! Attending graduate or professional school is a great way to increase your knowledge and boost your earning potential.
While some students take out more federal loans to pay for graduate school, many individuals choose private debt to fund their postgraduate studies. Here, you’ll learn the reasons for choosing private loans, how to compare debt from private lenders, and some other helpful tips to help you get an attractive rate.
Reasons to Choose Private Graduate Student Loans
Private student loans may be a good option if the following applies to you:
- You’ve already completed the Free Application for Federal Student Aid (FAFSA) to determine whether you qualify for federal loans.
- You’ve already borrowed as much as you can from the federal government.
- You can find a better rate borrowing from a private lender than from the government.
- You have a good credit score (or your co-signer does).
Ultimately, whether you choose a private graduate loan will depend on the rate you’re able to get.
Unfortunately, federally subsidized loans, which offer a lower interest rate and don’t begin accruing interest until six months after graduation, are only available to undergraduates. Graduate students can only get higher-interest federally unsubsidized loans, which start accruing interest the moment you receive the loan proceeds.
One word of caution: If you’re planning on working for the government or a nonprofit entity after graduating, you may want to choose federally issued loans. Special programs like the Federal Student Loan Repayment Program or Public Service Loan Forgiveness only apply to government-issued student debt.
If, after considering the above, you think getting a private graduate student loan is right for you, let’s discuss how to compare debt from different lenders.
How to Choose a Private Graduate Student Loan
When you look at loan comparison sites, you’ll see numbers like interest rates, APRs, and credit score requirements. We’ll discuss strategies for raising your credit score below. However, as a general rule, the higher your credit score, the better your interest rate.
When comparing different private graduate student loans, you’ll want to consider the following factors:
- Interest rates
- Annual percentage rates (APRs)
- Repayment terms
Now, let’s get into the nitty-gritty. By understanding what each of these terms means, you’ll have the know-how to make an educated and informed decision about graduate student loans.
A loan’s interest rate is the primary cost of taking out a loan. Each year, the lender will charge you a percentage of your outstanding loan’s principal amount. The higher the interest rate, the more you have to pay.
For a simple example, let’s say you have a $100,000 loan and a 10% annual interest rate. At the end of the year, you’ll have to pay $10,000 in interest ($100,000 X 10%). To get debt-free, you’ll need to pay your interest expense plus a bit extra to start chipping away at your loan’s principal amount of $100,000.
So, let’s say you pay $20,000 at the end of the first year. Of that $20,000, $10,000 would pay off the interest, and the other $10,000 would go toward your principal amount. After making the payment, you’d owe $90,000 of principal ($100,000 – $10,000).
The next year, you’d only owe $9,000 in interest ($90,000 X 10%). If you keep paying $20,000 every year, you’ll quickly erase your debt.
Now, let’s say you had an interest rate of 5% instead of 10%. Let’s assume you still have a $100,000 loan. In the first year, you’d only owe $5,000 in interest ($100,000 X 5%). So, if you made that same $20,000 payment, $5,000 would go toward interest, and $15,000 would go toward the principal, leaving you with an outstanding loan balance of $85,000 ($100,000 – $15,000).
The next year, your interest payment would only be $4,250 ($85,000 X 5%). That’s much lower than what you’d have to pay if your interest rate were 10%! As you can see, when you’re looking for a private graduate student loan, finding a lower interest rate can save you a lot of money.
Fixed- vs. Variable-Rate Loans
Let’s discuss one more aspect of interest rates you should keep in mind. Many student loans – including federal loans – have fixed interest rates. That means you’ll pay the same interest rate each year. Simple enough.
Fixed-rate loans benefit from being predictable. If you have a fixed-rate loan, you can plan and create a budget to pay off your debt. You won’t have to worry about changing interest rates.
However, some private loans have variable interest rates, which change based on the market. Typically, your interest rate will be a premium over an index like the Wall Street Journal Prime Rate or the London Interbank Offered Rate (LIBOR). As an example, your interest rate could be LIBOR plus 2.5%.
Some people choose variable rates because borrowers benefit if interest rates decline. When rates go down, you’ll pay less than you would if you had locked in a fixed rate at a higher level.
However, variable-rate debt is risky. If rates start climbing, you’ll have to keep paying more and more to keep up. You never know where interest rates might go. In 1989, LIBOR exceeded 10% for part of the year.
In general, fixed rates are a safer bet. However, if you’re willing to take the extra risk, variable rates might be something to consider.
A loan’s APR is calculated by combining the interest rate with origination fees.
Origination fees – also called administrative, processing, or underwriting fees – are one-time fees lenders charge to set up your loan.
Typically, lenders deduct the origination fee when they give you your loan proceeds. For example, if you wanted to borrow $50,000 to pay for graduate school, and the bank charges a 10% origination fee, you’d only receive $45,000 in loan proceeds. However, you’re still on the hook for paying back the $50,000.
If you need the full $50,000 to pay for school, you’d need to borrow closer to $55,555.55. After deducting the 10% origination fee, you’d be left with $50,000.
How to Use APRs to Compare Loans
Many lenders advertise their APRs in addition to interest rates. Reviewing APRs can be helpful because APRs provide a true side-by-side comparison between loans. In some cases, a loan with a low interest rate and a high origination fee may actually cost more than a loan with a higher interest rate. Let’s look at an example.
Suppose you want to take out a $30,000 loan and repay the principal within five years. After taking a look at the market, you find the following options:
- Option 1: The interest rate is 7%, and the origination fee is $300.
- Option 2: The interest rate is 6%, and the origination fee is $1,200.
Based on interest rates, you might automatically choose Option 2. However, when you take into account the origination fee, Option 2’s APR is 7.711%. Option 1, which appeared worse based on interest rate alone, has an APR of 7.422%, making it a better decision.
Finally, when looking at options for private graduate student loans, make sure to take into account how the loan’s term affects your total cost of borrowing. All else being equal, shorter-term loans are cheaper than longer-term loans.
Let’s illustrate with an example. Suppose you need $40,000 to pay for graduate school. You find the following options:
- Option A: A 10-year loan with an interest rate of 7% and a $2,000 origination fee.
- Option B: A five-year loan with an interest rate of 8% and a $3,500 origination fee.
With Option B, you’ll have a high APR of 11.953% and a monthly payment of $811.06. On the other hand, Option A has a much lower APR of 8.168% and a monthly payment of just $464.43. Option A looks much better, doesn’t it?
Not so fast. Because of the longer loan term, Option A will end up costing you a total of $15,732.07 in interest, while Option B’s total interest is only $8,663.35. That’s almost 50% less!
To get a full picture when comparing private graduate student loan options, use a loan calculator to determine your overall cost.
How to Boost Your Credit Score (and Get a Better Rate)
If you have some time before you start school, you may want to get your credit score as high as possible before applying for a loan. To raise your credit score, try the following:
- Pay off your debt. This one’s simple. If you have any outstanding bills, try your best to pay them. If you make your payments on time and use a low percentage of your available revolving credit, your credit score will improve.
- Don’t close old credit cards. Part of your credit score depends on the length of your credit history. To keep your credit score rising, don’t close old accounts.
- Don’t apply for too much new credit. Constantly applying for new lines of credit can negatively affect your credit score.
In general, try to be a responsible borrower and pay your bills on time. If you can get your credit score above 700, you’ll get access to much better private graduate student loan rates.
Get Help With Paying for Graduate School
If you or someone you know is thinking of borrowing money to pay for graduate school, visit College Finance for in-depth resources on financial aid, loan repayment, and more. The experts at College Finance will help you plan for a bright and successful future.