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Personal Loans vs. Private Student Loans: Which is Best?

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personal-loan-or-student-loanWhen borrowing money to pay for your college tuition, federal student loans are almost always fthe best choice.

These loans, backed by the U.S. government, come with low fixed interest rates of 4.53% for undergraduates and 6.08% for graduate students for the 2019-2020 academic year. They offer flexible repayment terms if you run into financial hardships after graduating.

But what if you need to borrow additional money?

College freshmen can only take out a maximum of $5,500 in federal student loans for the 2019-2020 academic year. Sophomores can only borrow $7,500, while juniors and seniors get a maximum of $7,500.

If you need more than that to cover your college costs, consider turning to private student loans or personal loans.

Private Student Loans

As the name suggests, private student loans come from private companies, with no guarantee from the U.S. government. Private lenders also furnish student loans.

Unlike student loans, though, the funds from a personal loan can be used for anything. You can use a personal loan to pay off high-interest-rate credit card debt, pay for travel to visit back home, or, of course, help pay for your college education.

But which option is better for you? That depends on your individual situation. Both personal loans and private student loans come with their own positives and negatives. Do a little research here to find your best funding option.

How They're the Same

Both personal loans and private student loans are typically unsecured. This means that there's no collateral. Collateral is physical property or a financial asset like stocks that the lender can take if you don't repay your loan as agreed. Loans with collateral are called "secured" loans. For lenders, secured loans are less risky.

Private student loans and personal loans, though, don't involve collateral. (It is possible to get a secured personal loan, but these are rare.) If you don't make your payments, your lender can't take anything from you. This increases the risk taken on by lenders, and is the reason why the interest rates on both private student loans and personal loans tend to be higher than those attached to secured loans.

Private student loans and personal loans are also installment loans. This means that you pay back these loans over time in monthly installments. After you take out your personal loan, you'll start making payments each month to your lender until the loan is paid back. You'll also make regular monthly payments on a private student loan. However, you usually don't have to begin paying this loan back until six months after you graduate.

Lenders will also pull your credit history from TransUnion, Experian and Equifax, and verify your three-digit credit score before approving you for either a personal loan or private student loan. The higher your credit score, the lower your interest rate will generally be.

Personal Loan Interest Rates

There are plenty of differences between personal loans and private student loans, too. One of the biggest? Private student loans often come with lower interest rates.

For instance, it's possible to qualify for a 15-year private student loan of $10,000 from one national lender with a fixed interest rate ranging from 4.99% to 10.72%. The rate depends on your credit score. If you choose a variable interest loan as of this writing, the rate ranges between 4.33% and 10.30%.

Compare that to the interest rates with personal loans. The same lender offers a personal loan of $10,000 with rates between 5.49% and 22.99%. Lending Club rates for personal loans range from 6.95% to 35.89%. But another international bank offers personal loans at rates between 6.99% and 16.99%. This shows that it pays to shop. Personal loan interest rates vary widely.

Personal loans, even at slightly higher rates, may offer some valuable benefits.

Personal Loan Benefits

The first is flexibility. You can use the funds from a personal loan to pay for anything, including education expenses. You must, though, use the money from private student loans to pay for education costs, including tuition, room and board or school supplies.

It's also more difficult to erase your student loan debt if you file for bankruptcy. If you file, you can discharge your personal loan debt fairly easily.

But the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 says that student loans are dischargeable only if you can prove that you can't maintain a minimal standard of living for you and your dependents because of your loan.

This is a high hurdle to overcome. Keep in mind, then, that even if you face enough financial hardship to declare bankruptcy, you might still not be free of student loan debt. You will, though, usually be able to eliminate debt from personal loans.

Christian Widhalm, New York City-based chief revenue officer of LendKey Technologies, said that is why interest rates tend to be lower with private student loans than personal loans: There's less risk for lenders.

You can also deduct the interest that you pay on a student loan if your modified adjusted gross income is $65,000 or less a year for individuals or $135,000 joint filers. If it is more than that, the amount you can claim will be reduced. If your modified adjusted gross income is $80,000 or more for individuals or $165,000 or more for taxpayers filing jointly, you can't deduct any of the interest you pay on your student loans.

And, of course, you can't deduct the interest you pay on any personal loan taken out from a private company.

What's the Right Choice?

Robert Farrington, El Cajon, California-based creator of TheCollegeInvestor.com - a site devoted to investing and personal finance for millennials - said that every borrower is different, and while a private student loan might be best for one, a personal loan might make more sense for another.

For instance, maybe your credit score is low. If so, a personal loan might be a better choice, Farrington said.

"Personal loans are typically easier to get than a private student loan because they don't require a high credit score," Farrington said. "They are designed to help you increase your credit score."

Leasha West, president of Kalamazoo, Michigan-based West Insurance & Financial Group, said that she has taken out both personal loans and private student loans. Which loan is best? That depends, she said.

West said that she likes the flexibility of personal loans. You can use the funds from these loans for anything. You might use the money from a personal loan to pay off a year's worth of tuition and then use the extra funds to pay off high-interest-rate credit card debt, for example. Personal loans, then, might be a good choice for borrowers who have financial needs in addition to funding their education.

But when it comes to repaying your debt? West said that personal loans are far more strict: Your loan repayment schedule is set once you borrow your money. You can't adjust it. With student loans, depending on your lender, you might be able to delay making your payments if you return to graduate school, lose your job through no fault of your own or experience financial hardships. Be aware that not all private lenders offer these options, so do your research before you take out one of these loans.

"There is no one answer for which type of loan is better," West said. "It all depends on the unique situation of borrowers."

Student Debt: Your Degree Choice Matters

Widhalm said that the key when borrowing any money for education is to consider the outcomes. You want to boost the odds that you'll receive a good return on the money you borrow. Your goal is to graduate from college into a good, well-paying job.|

"If you get a poetry degree, you might face a lower starting salary and higher unemployment rates when you graduate," Widhalm said. "There is nothing wrong with majoring in poetry. But if you are going to do that, don't borrow $125,000 to go to your dream university. Find a less expensive alternative."

A good rule of thumb? Widhalm says that you should never take on more in student loan debt than your expected first-year salary. if you expect a salary of about $60,000 your first year out of college, then, don't borrow more than $60,000 in loans to pay for your education.

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