Taking out a loan in order to attend school always feels expensive, but not all loans are created equally. Student loans can be either federal, which means made and guaranteed by the federal government, or they can be private, which is any other type of loan. The Department of Education is responsible for federal student loans while any bank or lender can offer private student loans.
Private loan lenders set the terms of the loan themselves, including interest rate, limits, and conditions of the loan. It’s important to understand the difference between federal loans and private loans before you decide which loan is best for your unique circumstances. There are pros and cons to each route that should be carefully considered before signing on the dotted line. For reference, about 90% of new student loans are federal, while the remaining are private.
Qualifying and Financial Aid
The process of getting a private loan is very different from the process of getting a federal loan. Federal loans are designed to help more Americans get access to a higher education, so the loan limits are based on financial aid information. The interest rate is subsidized, or paid, by the federal government and borrowers do not have to start making payments on the loan until after they have completed or left school. Private student loan interest is not subsidized and borrowers may be required to make payments while they are still in school.
When it comes to credit and co-signing, federal loans have very different requirements that private loans. Private loans will require an established credit report and in some cases a co-signer, but not always. The better credit record you have, the better interest rate and terms you will be able to qualify for. Federal loans do not require a credit record, but can help you establish the record as you pay back the loan. Having a co-signer doesn’t affect your eligibility for student loans and the amount of money you are qualified to borrow is based on your financial aid information and not your credit history.
The bottom line is that if you have financial need and/or poor credit history, a federal student loan can help you access the funds you need on predictable terms. But with a good credit history, the ability to make payments while you are in school, and/or parental support, a private student loan might be the better avenue.
The repayment period of a federal student loan doesn’t begin usually until six months after the borrower has graduated or stopped attending school. It’s possible to use federal student loans to gain a PhD without ever having to make a payment, as long as you don’t stop to take a break longer than six months and you are enrolled full time.
Some private loans may give you a grace period or defer your payments, but those terms are entirely up to the institution of your choice. Other financial institutions may require you to make payments while you are still attending school.
Perhaps the biggest difference in terms of repayment is that most private student loans are structured a certain way and are not expected to change, while federal student loans offer many different options for repayment that are flexible and easy to change. The Department of Education also allows borrowers to apply for deferment in circumstances like an economic hardship or loss of a job. Available plans also take into consideration your income and can change as your income changes. Private plans are usually the same loan terms for the life of the loan unless you refinance.
Finally, if you are pursuing a career in public service such as teaching or law enforcement, you may be eligible to have a portion of your loans forgiven completely if you chose federal student loans.
Federal loans seem like they have the clear advantage over private loans when it comes to repayment for flexibility, but the magic factor of a private loan is that the terms can be completely different from one institution to another, so it is possible to find loan terms that are more appealing that the federal option.
A difference in interest rate of just a fraction of a percentage point can mean the difference of thousands of dollars in the long run. Often, private student loans have variable interest rates, which means that the interest rate can fluctuate as you pay off the loan. While this gives your interest rate the option of going down, it also means that your interest rate will go up, both seemingly unpredictably.
With a federal student loan, the interest rate is fixed and set by Congress. Generally, federal student loan interest rates are much lower than private student loans, but they will not change for the life of the loan. This makes for a more predictable repayment and almost always saves money in the long run.
Which is the Loan for Me?
For most situations, federal student loans beat out private student loans as the more flexible, less expensive, and easier to qualify for option. However, private loans still have a place in the market. First, it is possible that a lender could offer a student loan with better terms than those set by the Department of Education. It’s always important for due diligence when seeking student loans to make sure you can find the best deal. Because of the subsidized nature of the loan and political pressure to keep federal loans in reach for citizens with financial need, federal student loans will almost always have better terms.
Second, it’s important to remember that federal student loans are only available in certain amounts, determined by the financial aid information you submit in order to qualify for the loans. If a student needed to take out more money than they qualified for in order to complete their studies, then a private loan would be the only option for them no matter whether it was a good loan or not.