This Millennial Learned The Downsides of Private Student Loans The Hard Way

May 07, 2018

I recently spoke to a young man who was evaluating his options regarding a private student loan that was in default. He had attended a prestigious school where his mother was a professor, which allowed him to attend tuition-free. However, his family had not saved to cover the other costs of college, including room and board, books and fees, so he found himself taking on student loan debt in order to cover those costs. Due to his mom’s employment and his family’s financial situation, he was offered very little in federal loans, requiring him to turn to the private market to fill the gap.

Fast forward to graduation, when he moved across the country to a high-cost-of-living city to seek a job in a competitive field, and he found himself still looking for work when the 6 month grace period expired on his student loans.

What happened next

At this point he learned very quickly how federal and private loans differed — while he was able to defer his payments on the federal loans until he found employment, and then was able to choose an income-based payment plan to accommodate the fact that he was in a field that starts out with very low pay, with room for rapid salary growth, the lender of his private loans was less sympathetic. Within months, he was in default on all of his private loans, despite numerous attempts to work with the lenders to work out a way to stay in good standing.

Where he is today

Ten years into his career, this young man has been very financially successful. So much so that he’s been able to completely pay off his federal loan, but the private loans continue to plague his credit score. Despite the loans being considered in default, he has been making payments on them ever since he found employment, but due to the fees and interest that had accrued during those early months of unemployment, the payments barely make a dent. The rub is that the lender is unwilling to work with him to put the loans back in good standing unless he is able to catch up on all the missed payments from all those years before first.

Evaluating his options

One thing he’s been considering is whether to settle the defaulted loans, by offering to pay a lump sum and call the loans “Paid as Agreed.” The upside to this is that it will start the clock on those defaulted loans falling off his credit report after 7 years, with the negative effects on his credit score softening with each passing year. The downside is that in the near-term, his credit score won’t really see any boost — having a settled debt on your record is actually just as bad as having a defaulted debt on your record. But in the long run, settling will make the default history, eventually. He was disappointed to learn this, as he had been hoping that settling would at least show that he’d paid, but alas, that’s not how prospective lenders see it.

What he would have done differently

The key take-away from this tale of debt is not just that private student loans should be used with caution, as the flexibility offered by federal loans simply doesn’t exist, but also what he shared with me about his regrets. When talking through these consequences, he lamented that he wished that he and his parents had known what they were getting in to when they accepted these loans in the first place. He had borrowed this money in order to take advantage of a study abroad program, as well as to live on campus, when he could have just as easily lived at home.

In other words, if he’d known then what he knows now, he would have simply not taken the loans as he didn’t NEED them, they just enabled him to do some really cool things that other students (like me, for example) didn’t get to do because they simply couldn’t afford it. In retrospect, he actually couldn’t afford those things either, which just reinforces one of my favorite financial planning mantras: student loans are NOT financial aid.