Private student loans are growing faster than Federal loans, which sometimes perplexes the experts. Historically, the best choices for education funding have always been Federal student loans, whether subsidized or unsubsidized. Apparently, "the times they are a changin," to paraphrase singer/songwriter Bob Dylan.

Why are private student loans often called "alternative" education financing? Since Federal student financing has dominated the market since its introduction, the term alternative student loans has been applied to private education financing. Until recently, the choices for private student loans were rather limited. But, in recent years, the number of choices has expanded.

With recent annual growth rates around 25% as compared to around 8% Federal loan growth, the end may be near for the term alternative student loans. The private sector has found that educational loans can be profitable and relatively easy to manage. As a result, their terms, historically much less favorable than Federal student loans, are becoming much more reasonable and borrower friendly.

Private student loans defined

Private student loans relate to education financing provided by private enterprise, without operational ties to the government. Numerous lenders offer them from Academic Finance Corporation to Wells Fargo Private Student Loans, with most of the alphabet in between.

Some private student loans come from "single source lenders" while others, like Sallie Mae (often compared to mortgage giants, Fannie Mae and Freddie Mac) and the Student Loan Network, are more like a consortium or group of lenders. All, however, are in competition for your student loan needs and, as competition increases, the terms for private student loans become more borrower-friendly.

Pitfalls of private student loans

Unlike Federal education financing, private student loans don't enjoy the weight of governmental backing. Therefore, they run the risks of all private enterprise. They must manage their operations efficiently, effectively, and – profitably. Should the interest rate market turn against them or should they suffer mismanagement, they face the potential for failure, as does any other personal, auto, or mortgage loan lender.

While total corporate failures are rare, they do happen. Sometimes, other issues can interrupt the flow of student loans. For example, at least one large private student loan consortium had to suspend all education lending in 2008. They hope to reenter the private student loan market in the future, but there are no guarantees they will.

Private student loans also often have fees that may offset a seemingly low interest rate. Some fee structures result in an unpleasant increase in your true APR (Annual Percentage Rate) that transcends the apparently wonderful interest rate. In other cases, many fees are "rolled into" the loan interest rate. This increases the effective APR to noticeably higher than similar Federal student loans.

When private student loans are a good choice

Because their loan terms (interest rate, repayment choices, etc.) are market driven, like auto, personal, mortgage, and commercial loans, private student loans are typically more expensive than Federal education financing. Along with normally higher interest rates, they also do not offer the latitude of repayment terms available with Federal financing. For reasons that should be obvious, they are not able to offer the loan forgiveness programs sometimes available with Federal student loans.

However, there are situations when private loans are the best choice for you. As the cost of education has skyrocketed in recent years, many students find their ability to access Federal student loans compromised. When you have reached your federal loan limits, private student financing looks much more attractive.

Once students have reached the limits of Federal Stafford and/or Federal PLUS Loans, typically less expensive than most other education financing, they may find private student loans as their best options. Keeping your eyes fixed on your goal, a college education and/or graduate school degree, should help you view private student loans in a new, more favorable light.

While the interest rates might be a bit higher and the associated fees may be somewhat annoying, private student loans can help you achieve this important goal. You should evaluate all the terms of the private student lenders you favor so you can make the best decision for you and your financial situation.

Federal vs. private

Should you still have the ability to receive Federal education financing, you should take advantage of the lower interest rates and liberal repayment terms. If you've exhausted that ability, take a serious look at private student loans, but – be sure to evaluate the programs you like to receive the most reliable, low cost financing available.

See also: How do private student loans differ from Federal student loans?