Stay Away From Private Student Loans

Last Updated Apr 27, 2009 2:04 PM EDT

Are you a perfect?

If not, stay away from private student loans. One silly mistake, like forgetting a single payment, could force you to pay many thousands of dollars extra on a private student loan.

Sure, that's a harsh punishment, but it's oh so legal. If your eyesight is sharp enough to read print that's the size of a flea's shadow, you'd understand the hazard.

Here's what you're up against according to Tim Ranzetta, the founder of Student Lending Analytics, an independent research firm. When Ranzetta was studying the fine print on the latest crop of student loan promissory notes, he noticed that several lenders including PNC, Chase and Sun Trust, have reserved the right to increase a private student loan's margin by two or three percentage points if a borrower goes into default. And missing one lousy payment qualifies!

So if you're paying nine percent on a private student loan and your check gets waylaid because you forgot to put a stamp on the envelope, the interest rate on your loan could jump to 11 percent or 12 percent. As the rate changes over the life of your variable loan, it will always be two or three percentage points higher than it was originally.

Lenders will insist that student loan borrowers don't have to worry. Just because they can ambush unsuspecting customers doesn't mean they would. And maybe they wouldn't. But really, should you trust these guys?

Even without this hazard, it's always best to borrow through federal loans first. Stafford Loans are the best bet for students and parents should consider taking out a federal PLUS Loan or use a home equity line of credit.