Federal vs. Private Student Loans: A Comprehensive Comparison

Navigating the world of student loans can be daunting, especially when trying to understand the differences between federal and private options. When talking to families, especially around this time of year, I typically get a lot of questions about student loans. There are questions about interest rates, about how to apply, about where to apply, and even if loans are necessary in the first place. Understanding these differences is crucial for making informed decisions about financing your education. This article breaks down the key distinctions between federal and private student loans, helping you determine the best approach for your individual circumstances.

Introduction to Federal and Private Student Loans

Student loans are a common way to finance higher education. Recent data underlines the popularity of federal loans among borrowers: Today, roughly 92% of outstanding student loans are federal. The remaining 8% are private. In many cases, families take out both types of loans.

Federal student loans are funded by the federal government and offer standardized terms and protections. Private student loans are offered by banks, credit unions, and other private lenders, and their terms can vary significantly.

Key Differences Between Federal and Private Loans

When choosing between federal and private student loans, several factors come into play. These include interest rates, repayment options, eligibility requirements, and loan forgiveness programs.

Interest Rates: Fixed vs. Variable

Federal student loans always have fixed interest rates. All loans taken out during an academic year have the same interest rate, and you’ll pay this same rate over the life of your loan. Most federal student loans don’t take your credit score into account; all borrowers get the same rate. The interest rate for each year’s Direct Student Loans for undergraduates is set by the 10-year Treasury Note. There is also a loan origination fee, which is deducted from the loan amount before the loan funds are placed in the student’s account.

Read also: Understanding Student Loans

Private student loans can come with either fixed or variable interest rates. Unlike fixed rates, variable rates can change over the life of your loan, depending on market conditions. This means your monthly payments could be unpredictable, changing from month to month. The private student loan interest rates for which you qualify generally depend on your credit score. Parents and graduate students with credit scores at least in the high 600s - or undergrads who apply with a co-signer with good credit - may get a lower interest rate with a private student loan than a federal one. A variable rate may substantially increase the total amount you repay.

Repayment Terms and Flexibility

Federal loans are typically more lenient in repayment than private loans, and offer several repayment plan options based on the student’s income. You will not have to start repaying your federal student loans until you graduate, leave school, or change your enrollment status to less than half time.

Private loans usually have stricter regulations around repayment. Many private student loans require payments while you are still in school. Repayment plans for private student loans vary by lender and usually don’t include income-driven repayment options. Make sure to carefully review the repayment terms of any private loan before borrowing.

Loan Forgiveness and Relief Options

Federal student loans offer several loan forgiveness options.

Public Service Loan Forgiveness: Work for a qualifying nonprofit or governmental organization for 10 years, and your remaining federal student loans may be forgiven. You should enroll in an income-driven repayment plan to benefit from this forgiveness.
Income-Driven Repayment Forgiveness: After 20 or 25 years of payments on an income-driven repayment plan, any remaining student loan debt will be forgiven.
Teacher Loan Forgiveness: Teach full-time for five consecutive years at a qualifying low-income elementary or secondary school to be eligible.
Borrower defense to forgiveness program: Federal borrowers can access the borrower defense to forgiveness program, which discharges a borrower’s federal loans if they’re defrauded or misled by their college. They may also be able to get their loans discharged if their school closes. Federal borrowers can also get loans discharged if they have a permanent and total disability.

Private student loan lenders don’t offer loan forgiveness.

Borrowers experiencing hardship can request a temporary pause of their federal student loan payments through a forbearance or deferment. General forbearance may be allowed for up to 12 months at a time and up to three years over the life of your loan. Interest usually accrues during a forbearance. If you qualify for a deferment, it can last for up to three years, and interest might not accrue. Income-driven repayment plans are another form of federal student loan relief. Your bills could be as low as $0 on an IDR plan if you have a very small income or are unemployed. Most private lenders offer deferments if you’re in the military or enrolled in school. Lenders that offer forbearances typically do so for at least 12 months over the life of your loan. Disability discharges vary by private lender.

Credit Requirements and Subsidization

You don't need to get a credit check for most federal student loans (except for PLUS loans). Federal student loans can help you establish a good credit record.

Private student loans may require an established credit record.

Undergraduate students with financial need will likely qualify for a subsidized loan where the government pays the interest while you are in school on at least a half-time basis. Private student loans are not subsidized. No one pays the interest on the loan but you.

Borrowing Limits

Federal student loans have relatively low borrowing limits. Undergraduates can borrow between $5,500 and $12,500 per academic year, depending on their year in school and dependency status. Overall, a dependent undergraduate can borrow up to $31,000 over their college career, while an independent undergraduate can borrow up to $57,500. (A dependent student generally has financial support from their parents; independent students are at least 24 years old and support themselves financially.) Graduate students can borrow up to $138,500 total in direct federal loans, including undergraduate borrowing.

Private student loan borrowing limits vary by lender, but generally, you can borrow up to your school’s cost of attendance.

Repayment Plans: Federal vs. Private

Federal student loans offer a variety of repayment plans to suit different financial situations:

Standard Repayment Plan: When you leave school, you’re automatically put into the standard repayment plan, which splits your total debt into 120 equal monthly payments over 10 years.
Income-Driven Repayment (IDR) Plans: IDR plans cap your monthly bill based on your income, extend your repayment term to 20 or 25 years, then forgive any remaining debt.
Extended or Graduated Repayment Plans: These plans start with lower payments that gradually increase until your debt is paid off. You won’t get loan forgiveness, like you could with an IDR plan.

Repayment plans for private student loans vary by lender and usually don’t include income-driven repayment options.

Types of Federal Student Loans

There are several types of federal student loans available:

Federal Direct Student Loan: We always recommend that a student take a federal student loan, officially called a Federal Direct Student Loan, first, and then potentially cover the remaining cost gap with a private loan.
Parent PLUS Loan: A Parent PLUS Loan is another type of federal loan utilized to pay for college costs, but the PLUS Loan is a parent loan rather than a student loan. The Parent PLUS Loan can sometimes have an interest rate higher than private loans. There is a significant loan origination fee on the PLUS Loan that is deducted from the loan amount before the loan funds are placed in the student’s account, so be aware of that fee before you consider applying.

How to Apply

To qualify for federal student loans, you must submit the Free Application for Federal Student Aid (FAFSA) in order to qualify for federal student loans, along with other aid, like the need-based Pell Grant and work-study.

Many colleges have lender lists that include private loans they have vetted. It is best to compare interest rates when researching private loans. Typically, the interest rate provided is tied to the borrower’s credit score. If you’re interested in applying for a MEFA Loan, there’s an easy, online process to apply.

Recommendation

Federal student loans, such as the Federal Direct Loan and the Parent PLUS Loan, generally have more favorable terms and conditions than private loans. Private student loans, which are offered by banks and credit unions, typically lack the borrower protections that come with federal loans. For that reason, it’s generally wise to consider private loans only if you have remaining costs after you’ve exhausted all federal loan options. We recommend using all federal loan eligibility before turning to private loans. Only after you’ve exhausted all federal student loans should you consider turning to private student loans to fill in any remaining cost gaps.

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