Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Sep 5, 2012

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As many student borrowers are painfully aware, jobs are scarce, the economy is still weak, and college debt must still be paid off. Student loans, whether they are private or federal, must be repaid regardless of any local or national financial crisis. Unfortunately for many borrowers and cosigners, this is where private and federal similarities end.

Unlike federal student loans, private loans are akin to other forms of privately offered financing. Private lenders—such as banks—set their own interest rates, policies, and fees for private student loans.

While borrowers can comparison shop for the lowest private student loan quotes online, they must keep in mind that all private student loans carry some downsides.

The Downsides of Private Student Loans

In comparison to private student loans, government-backed financing is far more lenient.

Federal college loans have interest rates that literally take an act of Congress to increase. Unfortunately, private student loan borrowers often find themselves vulnerable to variable interest rates.

Additionally, federal and private financing offer different options for borrowers seeking to defer payments.

The federal government offers deferments for six months after a borrower graduates. The government also offers deferments for borrowers who are currently facing financial difficulty, such as unemployment.

Private lenders, on the other hand, can often be merciless. Some lenders offer no reprieve for borrowers facing financial difficulty and will do everything they can to seek out defaulting borrowers. Worse, there are lenders that demand payment immediately after graduation and will allow loans to accrue interest as soon as a degree is earned.

The Powers of Private Lenders

Private lenders usually offer financing at variable interest rates. Borrowers must understand that their interest rates may change month-to-month. This means their payments could rise, fall, or remain stable. Naturally, any upward fluctuation in interest rates—and consequently monthly payments— can prove problematic for borrowers who are on a tight budget.

Private lenders also impose high penalty fees. These penalties, which can prove to be very expensive as they accumulate, are charged to borrowers who miss payments or payment deadlines.

While not all lenders charge borrowers high fees or have brutally short deferment periods, it is clear that there is a need for change and reform so that borrowers are protected from the elements of private lending that can be misused or abused in a time of severe economic stagnation.

Needed Change

The student loan debt bubble continues to soar past $1 trillion. Part of this gargantuan number is composed of private student loans that—thanks to some of the above-mentioned attributes—have swollen dramatically in amount over the years. While Congress can scarcely enact legislation that instantly provides jobs for the millions of unemployed and underemployed borrowers, it can enact bankruptcy reform laws.

While bankruptcy doesn’t absolve college loans right now, students and advocates have been pushing for reform that could enable private student loan borrowers to find relief through bankruptcy proceedings. If this legal change were to occur, it would allow millions of borrowers to rid themselves of their “student debt shackles” and put more of their disposable income back into the economy. Borrowers would not be getting off “scot-free” since they would still be facing the penalties that accompany bankruptcy, one of which includes a severe blow to credit.

For many borrowers, this would be a proper and even trade-off in exchange for the discharge of their debt. With the economy showing few signs of improvement and the student debt bubble relentlessly rising, legal changes may be the only avenue of escape for both borrowers and the nation as a whole.