Thinking about heading to college and planning your dorm room décor is exciting. Thinking about how you are going to pay for college is less exciting, but just as important. Student loans are one way you may be covering your college costs. If you'll be taking out private student loans, understanding what determines interest rates can be particularly important. Not only will a private loan's interest rate impact your monthly payment, it can affect how much you'll pay in interest each year and your overall cost to repay the loan.

For example, on a $10,000 undergraduate loan with a fixed 6.49 percent interest rate, in-school deferment for 45 months, a 6-month grace period and 15-year term, your monthly payment could be $111.05, and you would pay $9,989 in interest over the loan's lifetime. If the same loan has a 12.49 percent interest rate, your monthly payment could be $188.53 and you would pay $23,933 in interest — an $13,944 difference. When comparing loan options, look for the interest rate and the annual percentage rate (APR), which takes interest, fees, other finance charges, loan deferment and interest capitalization into account.

Understanding what determines interest rates for private loans, which will in turn impact how much interest accrues, can help you make an informed borrowing decision.

The Lender

Banks and other student lenders set their rates based on a combination of factors, including the market and proprietary risk assessments. As a result, lenders may offer different interest rates on otherwise identical loans.

The lender with the lowest advertised interest rate isn't necessarily the one that will offer you the best rate on your loan. Sometimes the advertised rate is only possible under certain circumstances, such as qualifying for a discount because you enroll in auto debit. Each lender's criteria and formula for determining your eligibility and rate are also different, which is why it's important to compare multiple options before taking out a loan. You might get approved for one lender's lowest rate and another lender's mid-tier rate.

Your Creditworthiness

Many undergraduate students don't have a sufficient credit history, which could make it difficult for them to get approved for a student loan on their own. Private student lenders consider each applicants' creditworthiness to determine their eligibility for a loan and the loan's interest rate.

A credit score could be part of the decision, lenders will also review your credit report to determine your creditworthiness. Financial information that isn't on your credit report, including your monthly income and expenses, may also be a factor.

A Cosigner

If you don't have an established or strong credit history, you may require a cosigner to qualify for a private student loan. A cosigner can be a parent, family member or friend who takes on a legal responsibility to help repay your loan.

Since the cosigner is also responsible for repaying the loan, their creditworthiness can impact the loan's interest rate. Even if you qualify on your own, a cosigner with good credit may help you get a lower interest rate. However, having a cosigner isn't a guarantee of approval or a good rate, particularly if the cosigner has poor credit or a high debt-to-income ratio.

Type of Loan

Private student loans typically offer a choice of fixed or variable interest rates. A fixed-rate loan will have a single interest rate that will not change for the lifetime of the loan. It may be a better option if you want to be certain your rate and monthly payments won't change.

A variable-rate loan may start with a lower interest rate than a fixed-rate loan, but the interest rate can change over time. As a result, your monthly payment could decrease or increase in the future as the interest rate changes. With its relatively low initial rate, a variable-rate loan could be a good option if you plan to pay it off quickly.

Interest-Rate Discounts

Most private lenders offer borrowers a discount on their interest rate during repayment — most commonly a 0.25 percent reduction — if they agree to make their monthly payments through auto debit. If you have multiple private student loans, you may have to enroll each loan into auto debit so the reduction gets applied to all of your loans.

Bottom Line

The interest for private student loans can vary depending on a variety of factors, some of which are beyond your control and others that you may be able to influence or choose. To understand what determines interest rates, look for offers from different lenders and compare APRs so you make an educated borrowing decision and potentially save money over the lifetime of your loan.

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