Making the Grade: Closing Out a Tuition Bill With a Personal “Gap” Loan

According to a recent study from Sallie Mae, families struggle to pay for college, with both parents and students feeling the financial pain.

According to the study, parental income is the “predominant source of money set aside for college”, with parental income comprising more than 50% of college costs. The problem is that mom and dad’s savings only account for about 40% of all college costs, with financial aid covering most of the remaining college tuition costs.

For college-bound families who can’t quite come up with 100% of college financing, taking out a personal loan can fill that “tuition gap” that occurs when parents and students only come up with 80%-or-90% of college costs. All told, 13% of college families take out private loans to help cover college costs. That compares to 51% who take out federally funded college loans.

Should You Take Out a Personal Loan?

A personal loan may work if a parent or student has exhausted the usual sources of college financing, including savings, grants, scholarships, federal loans, and family gifting.

But college financial consumers should be savvy about how they use a personal loan.

“The decision to use a personal loan for college financing needs to be done at the beginning of the college decision,” said Fred Amrein, CEO at PayForED, a college financing services firm in Newtown, Pa.

According to Amrein, college debt is different from other debt since it normally is used for children.

“Colleges only provide information one year at a time which limits a family’s ability to see how much debt will be required to get to graduation,” he said. “Before other loan types are taken the Direct Stafford student loan should be considered and this should be done starting before the student’s freshmen year. This will improve the student loan repayment and forgiveness options, and it also limits the parent liability of the debt.”

After that debt is used up, then an analysis of the best loan terms should be reviewed. “A personal loan is a consideration since it may have more favorable terms than a Parent PLUS loan, since they have high fees and a global interest rate,” Amrein said.

Low Rates a Win for Personal Loans

With interest rates still relatively low based on historic terms, any student loan – federal or private – can come with low rates, although federal student loans get the nod for the lowest rates.

“Though private interest rates are historically low, so are federal loans that are set at fixed rates,” said Tobin Van Ostern, co-founder at Savi Solutions PBC, in Arlington, Va. “Private loan interest rates can be variable and reading that fine print is important. We suggest borrowers be wary of private lenders that still have high rates as scams are prevalent as people are seeking alternatives during this economic crisis.”

Federal student loan interest rates are calculated in a much different way than private student loans.

“Interest rates on federal student loans are set by Congress, not by your individual circumstances,” said Jeff Mattonelli, financial advisor at Van Leeuwen & Company in Princeton, N.J. “Private student loans consider several personal factors such as the borrower’s credit, the loan’s term, and whether the rate is fixed or variable.”

For instance, a borrower with mediocre credit is likely to borrow at a higher interest rate than a borrower with outstanding credit.

“Sometimes, it may be helpful for a recent graduate to have a co-signer on the loan that has a more established credit history, to obtain a lower interest rate,” Mattonelli said. “This can be a risk for the co-signer however, because he/she would become responsible if the other borrower defaults.”

Potential Risks with Personal Loans

Students and parents need to be careful with personal loans, as they do have some limitations.

For example, personal loan repayment begins immediately.

“Unlike the vast majority of student loans, which allow you to defer your first loan payment until six months after graduating, your first bill for a personal loan would be due instantaneously upon receiving the money,’ said Roy Ferman, CEO at Seek Capital in Los Angeles, Ca.

Additionally, you’ll need a robust credit score to gain the best interest rate deals.

“Unless you have a substantial credit history and a high credit score, you’ll have to pay interest rates that are far higher than rates student loans offered, even to borrowers with bad credit,” Ferman said.

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Brian O’Connell

Brian O'Connell has been a finance writer at TheStreet, TheBalance, LendingTree, CBS, CNBC, WSJ, US News and others, where he shares his expertise in personal finance, credit and debt. A published author and former trader, his byline has appeared in dozens of top-tier national publications.