Student Loans

Student Loan Options: Federal vs Private Loans

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The process of applying to college and making a decision on where to attend can seem daunting. It’s often complicated by the element of finances – Figuring out what you can afford and how you will afford it. Student loans play a big part in this equation. Determining whether federal vs private loans will fit your needs is an important step in selecting the best college financing option for you.

What Is a Federal Student Loan?

Federal student loans are loans for college students borrowed directly from the U.S. government. Students don’t need to pay these loans back while they’re attending school at least half-time. There’s a deferment period of about six months to allow new college graduates grace to find employment before they need to start paying back their student loan debt. Federal student loans can amount to the cost of your college attendance minus any financial aid received.

Student loans from the government can be subsidized or unsubsidized based on need. With a subsidized loan, interest is not charged until the repayment period begins. With an unsubsidized loan, interest is capitalized while the student attends school and during the deferment period. All federal student loan options have a fixed interest rate.

Parents of college students can also take out federal student loans if they intend to pay for a dependent child’s college expenses.

To determine how much federal aid you’re eligible for when it comes to college expenses, complete the Free Application for Federal Student Aid (FAFSA) form. In addition to deciding which type of federal student loan you qualify for, it can also open doors to other types of financial assistance like grants and work study opportunities.

What Is a Private Student Loan?

Private student loans are not funded through the government, but through organizations such as banks, credit unions, and alternative lenders. The lender sets the terms, limits, and conditions of these loans, so they vary widely. Access to private loans is not based on need but on a number of elements determined by the specific lender, including your credit history, your ability to secure a co-signer, and your choice of school and major.

Though some private loans do not require payment while the borrower attends college, some do, and many do not offer a deferment period after graduation. Interest rates for private student loans can be variable over the lifetime of the loan and there are fewer flexible repayment options.

How Are They Different?

While federal and private student loans both help you afford a college education, they are dissimilar in many ways.

Interest Rates

Federal student loans feature a fixed interest rate that is tied to that of the 10-year Treasury Note at the time the loan is issued plus a set additional percentage. The interest rate stays the same throughout the loan’s repayment period.

Private student loans can have fixed or variable rates determined by the lender. With a variable rate, the repayment amount can change over the lifetime of the loan. This can be positive if the rate goes down, but it can be negative if the rate goes up significantly.

Repayment Terms

Flexible repayment options are a cornerstone of federal student loans. Borrowers do not need to start paying down this debt while they attend college. After that, there is a six-month grace period before mandatory repayment begins. If the borrower can prove financial need, federal student loan repayment can be put on deferment/forbearance. Additionally, the monthly repayment amount can be lowered based on income. Most notably, after 20-25 years, a borrower can qualify for a need-based loan cancellation and, if you pursue a career in public service, your loan will be forgiven after 10 years. Federal loans also uniquely discharge upon the borrower’s death or permanent disability.

Private lenders do not offer the same type of repayment options. Some private loans are due while the borrower is still attending school. They are not required to offer flexibility based on need or career path and do not provide private student loan forgiveness. Even so, many lenders are willing to work with you to create a plan that best fits your financial situation. It is important to note that since most private student loans require a co-signer, even in the case of the borrower’s death, the co-signer will be responsible for the debt.

Loan Default

Defaulting on a loan is never a positive thing, but borrowers do have more default protections in place with federal student loans compared to private student loans. To start, a private loan is considered in default 120 days after payment is due compared to 270 days for a federal loan. Private lenders can seek payment from a co-signer when a payment is simply late – they do not have to wait for the loan to be in default.

Any type of lender can add collection charges when a loan goes into default, which can increase the balance up to 40 percent. The government can garnish a defaulted borrower’s wages without a court order, whereas a private lender needs a court order to do so. However, the government can garnish only up to 15 percent of your disposable income while private lenders can garnish as much as 25 percent.

Federal vs Private Loans: How to Choose?

In almost every scenario, a federal student loan is preferable to a private student loan for students entering or currently enrolled in college. However, after graduation, and once you’ve established a solid work and credit history, it might make sense to refinance your student loan privately. If interest rates have gone down, a private lender might be willing to offer someone with good credit better rates than they were able to attain as a young person with no financial history.

If you have a co-signer with exceptional credit and a strong financial history, you may be able to secure a private loan with a much better interest rate than a federal loan. If the co-signer is willing and able to help with repayment while the borrower is still in school (e.g., a parent), a private loan could be a better fit.

An easy way to compare federal and private student loans for your unique situation is to fill out a FAFSA and also apply online for private loans. Online loan aggregators will quickly present a variety of student loan options to consider.

Paying for college is a large burden, but a worthwhile investment. Federal and private student loans can help you afford a higher education that will set you up for future success!