What's the Difference Between Federal and Private Student Loans?
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Figuring out how to pay for a college isn’t easy, but it’s possible, so long as you’re armed with the information you need to make a well-informed decision. In this article, we’ll demystify the distinctions between federal and private student loans and help you figure out which option is best for you.
Federal student loans are issued and guaranteed by the U.S. Department of Education. As a result, the interest rates are fixed — not determined by your credit scores or other financial factors like they are with private loans. Your school determines the loan type(s) and the amount you are eligible to receive each year. You apply for a federal loan by filling out the Free Application for Federal Student Aid (FAFSA) form, which the Department of Education will evaluate to determine your expected family contribution toward your education and offer you financial aid accordingly.
In addition to the major benefit of fixed interest rates, many federal loans have income-based repayment plans and loan forgiveness for people who work a certain number of years in teaching or public service. Additionally, anyone who qualifies can receive a federal subsidized or unsubsidized loan, regardless of credit history, whereas private loan servicers run a credit check to determine eligibility. If your credit history is not up to snuff, you might have to get a cosigner on your private loan or risk being denied the money altogether.
What types of federal loans are there?
Not all federal student loans are designed in the same way. Let’s break down their differences.
- Subsidized federal loans. In your loan searching process, it’s a good idea to consider this type of loan first, as subsidized federal loans often have the lowest interest rate on the market. You can find the current interest rate for federal loans on the website for Federal Student Aid. Another significant benefit of these loans is that the government also subsidizes the interest — meaning they’ll pay it for you — while you’re in school and for an additional six months once you graduate. You’re also allowed a post-graduation grace period of six months before you need to start paying these loans back.
- Unsubsidized federal loans. These loans are usually the next best option. The major difference is that interest on an unsubsidized loan begins to accrue as soon as you take on the debt, although you’ll enjoy the same lower interest rate you’d get on a subsidized loan. Unsubsidized loans are usually available for students who haven’t met the financial need requirements for subsidized federal loans.
- Direct PLUS loans. Unlike the two other types of federal loans, Direct PLUS loans are only available to the eligible parents of students (known as parent PLUS loans) or to graduate or professional students (known as grad PLUS loans) through schools participating in the Direct Loan Program. Parents with a good credit history can secure these loans on behalf of their child, up to the entire cost of attendance minus any financial aid your child already receives. Parents are fully responsible for paying back the debt, even though the loan is taken out on behalf of the student.
Private student loans have some benefits of their own but are generally a good idea only after you’ve taken full advantage of any money available through the federal government. Private loans almost always have higher interest rates than federal loans, so you usually end up paying more over the life of the loan. If you have an extremely good credit history, a lender might be able to offer you an interest rate as low as 3 or 3.5 percent; however, private loans almost always have a variable interest rate. That means the interest rate can change over the course of the loan in response to various market factors and could leave you paying far more than you initially anticipated. Additionally, such low interest rates are only offered to those with very high credit scores, so most borrowers will pay far more for a private loan.
Private loans usually require payments when you’re still in school and don’t come with the same post-graduation grace period that federal loans do. Also, private loans are not eligible for forgiveness and deferment programs the way that federal loans generally will be. Additionally, while federal loans are discharged upon the borrower’s death (or permanent disability in some cases), that’s not the case with private loans. If you had a cosigner, your debt would transfer to that individual upon your death or could be paid out of your estate.
Again, while private loans can provide some much-needed additional assistance for certain students, it’s generally wiser to look at your federal options first.
Hopefully, you now feel more prepared to evaluate and determine which type of student loan is best for you. It’s a big decision that can have lasting ramifications for you and your parents.