While rising college loan balances remain a cause of concern, there is a bit of good news. The number of students using private loans from commercial financial institutions has declined while the number of those opting for federal loans has risen.
A study conducted for the National Center for Education Statistics (NCES) found that private student loans fell by 50% from 2008 to 2012.
The distinction is an important one. Private loans are different from federal loans because they're made by banks, credit unions, and other commercial institutions and are not federally guaranteed.
They tend to be like other commercial loans, with terms usually based on market conditions and the borrower's credit history.
Just another consumer loan
Like other consumer loans, the lenders set the terms and conditions of the loan, usually basing them on the market and the borrower’s credit history. Federal loans generally have terms that are more advantageous to the borrower.
According to the research, private loans only accounted for 5% of undergraduates in 2004 but surged to 14% by 2008. It then dropped to 6% in 2012.
At the same time, the percentage of students taking out federal loans through the Stafford program increased from 35% to 40% over the same period.
It's probably no surprise that private loans dropped sharply after 2008, since the credit crisis hit with full force late that year. Lending standards tightened and banks and financial institutions made fewer loans for any purpose.
Better off with federal loans
“Generally private loans have stricter terms and harsher penalties for non-payment than federal loans do,” said Jennie Woo, Ed.D., lead author and a senior education researcher at RTI, which conducted the study. “Students who are eligible for federal loans are better off getting them instead.”
The study focuses on one possible reason so many consumers are struggling with college loan debt. The proportion of borrowers who took out private loans was highest at private for-profit schools, especially in 2008. These schools tend to be among the most expensive, and some – like Corinthian and ITT – have closed their doors, stranding students with the highest loan balances and the least favorable terms.
The Consumer Financial Protection Bureau (CFPB) advises students to always choose a federal loan if possible. It points out that the interest rate on a federal loan is fixed, while the rate on private loans often fluctuates.
