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Originally published Saturday, June 30, 2012 at 8:01 PM

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How private college loans differ from fed program

Private student loans are widely considered an option of last resort only after federal loans, scholarships and grants have been exhausted because they tend to be more expensive and come with fewer safeguards.

The Associated Press

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And where does the federal government get this money to make these "safe"... MORE

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NEW YORK — For college-bound students, the easy money seems to be everywhere.

The website for Discover's student loans says it can help: "Cover up to 100 percent of your college tuition, housing, books and more." An online ad by Wells Fargo states that "It's Quick, Easy and Free to Apply."

Over on the site of student lender Sallie Mae, the words "Low rates!" jump off the page.

It's tempting marketing for cash-strapped students and parents who may be scrambling to figure out a way to cover any remaining college costs as the fall semester approaches.

But the offers from banks and credit unions have key differences from Stafford loans, which are issued by the U.S. Department of Education.

Private student loans are widely considered a last resort only after federal loans, scholarships and grants have been exhausted, because they tend to be more expensive and have fewer safeguards.

Still, students and families might think there are no other options this late in the game, when they're already set on a school with steep costs. For an in-state public college, the average bill now comes in at more than $17,000 a year. Many private schools cost over $50,000 a year.

"Students are limited in how much they can take out in federal loans, so they may feel there's no other choice," says Mark Kantrowitz, publisher of Finaid.org, which tracks the financial-aid industry.

Before you apply for a private student loan, here's what you should know:

Interest rates

The low interest rates that banks dangle in front of borrowers online can seem like a steal, but keep in mind those advertised rates are reserved for borrowers with sparkling credit histories.

Discover, for example, notes that variable rates are as low as 3.25 percent. If you don't have a top-notch credit score, however, the rate can be as high as 8.25 percent.

In addition, variable rates rise and fall in tandem with a benchmark rate. Since benchmark rates are at record lows, the rates are bound to rise in the years ahead.

By contrast, the rate on federal student loans is fixed at 6.8 percent over the life of the loan, regardless of a borrower's credit score. (Certain loans reserved for those in financial need have an interest rate of 3.4 percent. But that lower rate expires July 1 and will rise to 6.8 percent again unless Congress agrees to extend it).

Some private lenders also offer fixed rates, in which case borrowers will need to do the math on which option makes more sense for them. Students who think they'll repay the loan fairly quickly, for example, might opt for the variable rate since rates aren't expected to rise dramatically soon.

To get the best rate on a private loan, a parent will likely need to co-sign, since students generally have very thin or nonexistent credit histories. Although it's not necessary, Sallie Mae says 90 percent of the loans originated last year had a cosigner.

One way to reduce costs is to chip away at the loan while in school rather than waiting until after graduation to start repayment. This is critical because the interest accrues during those years, which sharply pushes up the amount that you owe.

Sallie Mae, for example, encourages students to pay off either their interest charges or $25 a month while they're in school. On a $10,000 loan, that can save up to $5,300 over the life of the loan.

If students opt to make payments while in school, Sallie Mae also offers a discount of up to 1 percent.

The lender may offer other types of discounts. At Wells Fargo, borrowers can get up to a 0.5 percent discount on their rate depending on the type of checking account they or their co-signers have with the bank.

Safety nets

The interest rate shouldn't be your only concern.

The Consumer Financial Protection Bureau released a summary of the 2,000 complaints it received on private student loans. One of the common themes was difficulty negotiating repayment terms in times of financial duress.

This may be because it's up to the bank to decide whether to allow borrowers to postpone payment if they're unemployed or having trouble making ends meet.

Borrowers who are having difficulty working out a payment plan or feel they were misinformed can file a complaint with the Consumer Financial Protection Bureau at www.consumerfinance.gov/complaint or by calling (855) 411-2372. The agency will contact the lender on behalf of the borrower.

"Many people have been able to get errors corrected or information about repayment options," said Rohit Chopra, student loan ombudsman at the CFPB.

With federal student loans, borrowers who are unemployed or suffering economic hardship can opt to defer payments. Economic hardship deferments are granted one year at a time, while unemployment deferments are granted in six-month increments.

This is by no means a giveaway, since interest charges keep piling up during deferment. But it provides temporary relief to students in real need without destroying their credit profiles.

Another important safeguard with federal loans is that borrowers can apply for a program called Income-Based Repayment, which caps monthly payments at 15 percent of annual income above $16,300.

Those who earn less don't have to make any payments; any remaining debt after 25 years is forgiven, or 10 years for those entering public service jobs.

Eligibility for the program is determined by weighing the amount owed against income.

There's no similar program with private student loans. But for those struggling to make ends meet, the lender may in rare cases reduce the interest rate or minimum payment amount to make the monthly payment more manageable.

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