Banks and other lenders advertise their private student loan services extensively, and young, first-time borrowers may be under the impression that these loans are a smarter option than federal aid when it comes to higher education. While there are some select cases where this may be true, the vast majority of borrowers would benefit from choosing a federal student loan program instead.
There are less stringent requirements for receiving a federal student loan. Borrowers don’t need to have an established credit history or a co-signer, meaning most students who are just graduating high school are able to obtain them. There is an element of financial need to federal student loans, so very high income families may not have access to the most forgiving federal loans. Borrowers won’t have to show an income because they are expected to be in school full time, with the expectation of earning an income after graduating.
Federal student loans have fairly low interest rates set by the Department of Education. There are options available for either subsidized or unsubsidized federal student loans. With a subsidized loan, the government actually pays the interest on the loan while the borrower is enrolled in school and for the first six months after they graduate.
Although federal student loan options are often criticized for being too complicated to fully understand, the wide variety of repayment options available under federal student aid make them more flexible and easier to pay back than private student loans. The standard repayment plan will be the least expensive option over the lifetime of the loan, but keeping a loan in good standing and building credit can be a very helpful way for a newly-graduated professional to establish their adult lives. Achieving that means having access to flexible payment plans that won’t drag your entire credit score under the bus if you lose your job or experience some other kind of financial hardship. There is no penalty for paying off the loan early, so if you are able to make larger payments you will be able to save more money on interest. You may also consider refinancing and consolidating if you have a strong credit history.
Federal student loan plans have payback options that might cap your monthly payment based on your income, defer payment for a time, and eventually, after a fixed period, forgiveness. Many financial aid options will forgive the remainder of your debt after you make ten years of on-time payments. Some options require more than ten years. The idea behind this is if you do your best to pay the debt every month, everything else that you owe after that period of time will be forgiven.
Ten years can seem like a really long time to be paying off your loans, but the staggering price tag of higher education makes ten years seem like a huge relief compared to the thirty or more years many graduates are facing. Borrowers will likely save money in the long run by paying the loan back as quickly as they can and avoiding interest, which can double or triple the amount of money you pay over longer periods. If you do need lower monthly payments, though, there are options to extend your repayment term - which many borrowers take advantage of.
Cumulatively, all of these benefits make federal student loans a better fit for most first time borrowers. There are a handful of situations where a student may need to take private loans instead. One common reason for this is when a student’s parents have a high income but are unable or unwilling to pay for the education costs of their child.
One of the advantages of federal student loans is also a contributing factor to our nation’s growing debt crisis: accessibility. Private lenders grant loans based on a risk assessment of whether or not that person will pay the money back (your credit score). A federal loan operates under the assumption that a person will be able to find a job in their field and make enough money to pay back their student loans. But there is no consideration given to whether or not a student’s chosen career path is going to provide them with a salary sufficient to pay back those loans. Private lenders, while expensive, will be more realistic about investing in you and your education.