Personal loans are increasingly popular, and it’s easy to see why. They have easy applications, and if approved, lenders will disburse the money directly to you within a few days. When it comes to personal loans, students may find them to be a tempting alternative to traditional student loans. However, lenders often have restrictions prohibiting borrowers from using personal loans for education. But even if a lender allows you to use personal loans for school, it may not be a good idea because of the higher rates and stricter repayment terms that apply to personal loans.
What Is a Personal Loan?
In recent years, more borrowers have been using personal loans to finance major purchases and consolidate debt. In fact, Experian reported that the amount of total unsecured personal loans increased by over 33% between 2021 and 2022. But what are personal loans? Personal loans are a type of installment loan, meaning you apply for a loan for a certain amount and repay it in monthly installments over a specific period, such as three years. Personal loans are generally unsecured, so you don’t have to use any valuables — like a house or car — as collateral to secure the loan. Instead, creditors review your income and credit to determine whether you’re eligible for a loan and what rates should apply.
Personal Loans vs. Student Loans
Both personal loans and student loans allow people to take out money for their expenses. However, personal loans differ from student loans in several key ways that can make them appealing.
| Personal Loans | Student Loans | |
|---|---|---|
| Interest Rates | 5.20%-35.99% | 4.48%-18.00% |
| Origination Fee | 0% to 9.99% | 0% for most private loans 1.057% to 4.228% for federal loans |
| Repayment Terms | 2-7 years | 5-15 years |
| Borrowing Limit | $50,000 for most lenders | Up to total cost of attendance |
| Time to Disburse | As soon as the same day you apply | Can take several weeks |
| Payment Method | Disbursed directly to borrower | Paid to school |
| Restrictions | Typically prohibits using the money for education expenses | Can only be used for education expenses |
Personal Loans Are Quick
With student loans, the application process can be complex. You have to fill out the Free Application for Federal Student Aid (FAFSA) months in advance to apply for federal student loans, and private student loans usually require borrowers to apply weeks or months before the start of the semester. By contrast, personal loans are a quick source of funding. You can usually apply online and receive a decision within minutes. And with some lenders, the loan funds are disbursed to approved borrowers as soon as the same day you apply.
Personal Loans Give You a Lump Sum of Cash
If you’re approved for a student loan, the lender pays the loan amount to your college or university. If any money is left over after covering tuition, room and board, and school-required fees, the remainder is issued to you, so you may only get a small amount of cash (or no cash at all). Personal loans work differently. Lenders disburse the total amount to you, so you get a lump sum of cash to use as you wish.
Your Borrowing Amount Isn’t Restricted By Your School
When you take out a student loan, the lender works with your school to verify your expenses. You can only borrow up to the school-certified cost of attendance, which is based on a formula of typical expenses. If you have unusual circumstances that would require additional funds, you may not qualify for a larger loan amount. The cost of attendance doesn’t limit personal loans. You can borrow up to the lender’s maximum depending on your credit and income.
With Personal Loans, Students Should Be Aware of These 5 Drawbacks
At first, personal loans can sound like excellent solutions. You can apply for a loan and get money quickly, and you aren’t limited by your school’s formula for how much you need. However, personal loans have some significant drawbacks for college students. Here are five key reasons to think twice about using a personal loan for your education:
1. Some Lenders Prohibit the Use of Personal Loans for Education Expenses
Personal loans have few restrictions on how they’re used, but there is one notable exception: many personal loan lenders strictly prohibit the use of the loan for education-related expenses. If you’re planning on using the loan for tuition, dorm fees or other expenses, the lender will deny your request. When you sign the loan agreement, you typically have to certify — under penalty of perjury — that you won’t use the money for education expenses.
2. Personal Loans Tend to Have Higher Interest Rates
Even if you find a lender that allows you to use a personal loan for college costs, it’s unlikely to be wise. In general, personal loans have significantly higher rates than student loans. According to the Federal Reserve, the average rate for personal loans was 12.17 % as of August 2023, the last available data, but rates can be as high as 35.99%. Rates for student loans are much lower. As of the 2023-2024 academic year, federal loan rates are as low as 5.5%. With private student loans, rates range from 4.48% to 18.00% — substantially lower than the maximum rates some personal loan lenders charge.
3. Personal Loans Often Have High Origination Fees
Unlike student loans, personal loans often charge high origination fees — fees deducted from the loan amount at the time the loan is issued to you. Fees vary by lender, but they can be as high as 9.99% of the loan amount. Student loans tend to have much lower fees. Private student loan lenders rarely charge any origination fees, and federal student loans tend to have much lower fees than personal loans. For loans issued for the 2023-2024 academic year, federal loan fees range from 1.057% to 4.228%.
4. Personal Loans Tend to Have Shorter Repayment Terms
If you take out a personal loan, be prepared for a larger monthly payment. Not only do personal loans have higher rates than student loans, but they usually have much shorter repayment terms. Some lenders offer terms as long as seven years, but those are a rarity. Most lenders offer terms between two and five years, and none have grace periods or allow you to defer payments while in school. Student loans typically have repayment terms between five and 15 years, and with some federal student loan payment plans, you can stretch your payments over 30 years. Plus, federal loans have alternative payment plans that base your payments on your income, reducing how much you have to pay every month.
5. It Can Be Harder to Qualify for a Personal Loan
Student loans are specifically designed for college students. With federal student loans for undergraduate students, there are no credit checks and no income requirements. Although private student loans require good to excellent credit, they allow borrowers to apply with co-signers. If you don’t meet a lender’s eligibility requirements on your own, adding a co-signer can improve your odds of getting a loan. Personal loans are more challenging. Lenders usually require good to excellent credit and income from full-time jobs, and many lenders prohibit the use of co-signers or co-borrowers, so you have to apply for a loan based on your own credit and income.
Instead of Using Personal Loans for School, Apply for Student Loans
For those considering personal loans, students should know that they are usually a more expensive form of debt than student loans, and they have shorter repayment terms. Before turning to a personal loan for tuition or college living expenses, consider the following alternatives:
- Talk to your financial aid office about emergency loans: If you need money to cover an unexpected expense or to tide you over until your student loans come through, your college may be able to help. Some schools offer emergency loans to cover small, short-term expenses.
- Fill out the FAFSA: Complete the FAFSA by federal, state and school deadlines to qualify for federal loans, grants and institutional aid.
- Check emergency resources: Some community organizations offer financial assistance, food pantries or other programs for college students. You can find local resources by visiting 211.org.
- Apply for private student loans: If you need additional financing for college, private student loans can be a solution. You can borrow up to the total cost of attendance at a lower rate than you’ll usually find with a personal loan, and you can have up to 15 years to repay it.
With ELFI, you can take out private student loans for undergraduate or graduate degrees, and you can add a co-signer to your application to help you qualify for a loan and better rates.
