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Differences Between Federal & Private Student Loans

September 14, 202118 minute read

What's the Difference Between Federal and Private Student Loans?

If you’re planning on attending college this year, chances are you’re trying to figure out how to pay for it. And if you’re considering taking out a student loan, you’re in good company. According to the Federal Reserve Bank, 54% of college students took on some form of debt for their education, including federal and private student loans.

Although student loans may provide a convenient way to pay for higher education, it’s important that you get the right student loan for your situation, or you could end up paying a high price for the convenience. For example, depending on the type of student loan you get, you may have to pay for your education for decades versus paying for it over a limited number of years. Or, if you experience financial struggles after college, you may make the grim discovery that there are no debt forgiveness options available to you.

But what constitutes the right student loan is different for everyone. What’s available for you may not even be an option for another student. Therefore, a good way to determine the best loan for your situation is understanding your options, especially when it comes to the differences between federal and private student loans. Doing your homework now may save you years of financial remorse later.

What is a federal student loan?

Federal student loans are loans that are administered by the U.S. Department of Education. There are four types of federal student loans available to students and their parents: direct subsidized loans, which require exceptional financial need; direct unsubsidized loans, which are available regardless of financial need; direct consolidation loans, which allow for two or more federal student loans to be consolidated; and direct PLUS loans, which are specifically for parents of students and do not require financial need for eligibility.

Students don’t need to have a certain credit score to qualify for federal student loans. Instead, they must show proof of financial need according to the standards established by the U.S. Department of Education.

Although most federal student loans may only be used for educational expenses, some loans may be available for living expenses during college. Federal student loans may also have lower interest rates compared to private loans, and — more importantly — they sometimes offer flexible repayment plans and debt forgiveness.

What is a private student loan?

Broadly speaking, private student loans are provided by a bank, credit union or other financial institution. Private student loans are not based on financial need. To qualify, students must instead have sufficient credit. If your credit score does not meet the lender’s standards, you may need a cosigner to help qualify for a loan.

Unlike federal student loans, which are restricted to paying for tuition, private student loans may be used for any purpose. For example, you may use them for additional expenses, such as books, computers, room and board, living expenses, and transportation. Private loans also tend to have higher borrowing limits compared to federal loans.

Bear in mind that some private loans require you to immediately begin repayment, even if you’re still in school. And although most private loans from banks and credit unions don’t offer loan forgiveness options, some private loans from state-based organization may. You’ll want to check with the loan’s originating financial institution to find out if debt forgiveness is an option. If forgiveness is an option, inquire about the requirements for forgiveness.

How are federal and private student loans different?

Both federal student loans and private student loans have the same general purpose — financing higher education. However, there are significant differences between the two types of loans, including the interest rates, application and qualification processes, and repayment and debt forgiveness options. These differences are key to deciding which type of loan is right for your situation.

Interest rates on federal student loans

In general, the interest rates on federal student loans are often lower than for private student loans. The average federal student loan for an undergraduate degree varies from year to year. As of the beginning of the 2021-2022 school year, the fixed interest rate was 3.73% for loans disbursed between July 2021 and July 2022. Interest rates for graduate loans were 5.28% for the same period. And PLUS loans, which are used by graduate students and their parents, had an interest rate of 6.28%.

The following types of federal student loans treat interest rates differently:

  • Direct subsidized loans — A subsidized loan gets its name because the federal government pays some of the interest for you. The government pays the interest on the loan while you’re in school if you’re enrolled at least half-time, as well as during the first six months after you graduate and during any period of deferment. These loans are provided to students who demonstrate a higher degree of financial need.
  • Direct unsubsidized loans — With these federal loans, the government does not pay any interest on your behalf. Additionally, students are not required to demonstrate a financial need to receive these loans, as compared to the subsidized loans.

Another distinguishing feature of federal student loans is that the interest rates are fixed. Although the rate for new loans changes from year to year, the interest rate of a disbursed loan does not change during the repayment period.

Interest rates on private student loans

Interest rates for private student loans are typically higher than interest rates for federal student loans. One main reason for the higher rates is that many college students have weak or nonexistent credit histories, or they lack a stable income. These are factors that may negatively affect interest rates on private loan applications.

Unlike federal student loans, interest rates for private student loans may vary a great deal depending on a variety of factors, including:

  • Your credit rating
  • Whether you have a cosigner
  • Current prevailing interest rates
  • Your income

Some private student loans may offer fixed interest rates, but many have what are called variable rates. This means the interest rate may change over time. For example, a private loan with a variable interest rate may start its life with a low rate, but the rate may increase over time depending on the benchmark rate to which it’s linked, such as the federal funds rate. If the federal funds rate increases or decreases, then the interest rate for a loan linked to it may increase or decrease as well.

Applying for federal student loans

The application process for student loans is notorious for its involved and detailed requirements. And qualifying for loans can be tricky, especially if you’re just starting out on your own and haven’t established a credit history. But applying and qualifying for student loans is actually a relatively straightforward process, and you may feel less intimidated if you know what to expect.

To apply for a federal student loan, you’ll need to fill out a Free Application for Federal Student Aid, or FASFA, supplying information about your (and, if you’re considered a dependent, your parents’) income, tax returns, W-2 forms, etc. The federal government considers your income from all sources when determining what loan amount you may qualify for.

The FAFSA deadline is a fixed date, and it occurs on June 30 of the academic year after the year you plan to attend. For example, if you plan to attend university beginning in the 2022-2023 academic year, the federal FAFSA deadline would be June 30, 2023. However, the FAFSA application is available as early as Oct. 1 of the year before your target enrollment date. For example, for the 2022-2023 school year, the application for students in Washington state would have been available beginning on Oct. 1, 2021.

In addition to determining what federal student loans you may qualify for, a FAFSA application is also required to qualify for some grants and scholarships that don’t have repayment requirements. However, it’s recommended that current or prospective students submit their FAFSAs as early as possible since some of these funding sources are limited and may run out well before the federal submission deadline. 

Applying for private student loans

Private student loan applications must be made with individual lenders or state-based organizations. Note that, unlike federal student loan applications, your parents’ income may not be considered unless they’re cosigners on the loan. Private student loans typically do not take financial need into account. Instead, the qualification process for these loans focuses on your personal credit history and income.

In order to qualify, student borrowers must meet the lender’s standards for credit or income to be approved for a loan. You may be able to secure a better interest rate or more favorable terms by applying for private student loans from a financial institution with which you have an existing relationship. And unlike federal student loans, there isn’t a hard-and-fast application deadline for private student loans. Instead, you’ll likely work with the individual private lender to set up an application timeline that works for you.

Repayment and debt forgiveness on federal student loans

As a higher-education student — or a prospective student — you’re most likely excited by the prospect of earning your degree and starting a new career. To that end, make sure you understand the terms of the student loan that you plan to take out.

In general, students will be expected to make monthly payments of principal and interest on their federal student loans after they complete their education and after their grace period has expired. However, federal student loans sometimes have flexible repayment programs. For example, borrowers may have their payments adjusted based on their income, or they may be able to extend their repayment period to make their monthly payments more manageable.

The following are examples of flexible repayment plans available to qualifying federal student loan borrowers:

  • Grace periods — Federal student loans have a built-in six-month grace period. That means you don’t have to start making payments on your loans until six months after you stop attending school.
  • Forbearance — Under some circumstances, you can pause your student loan payments for a specific period. Forbearance may occur for circumstances such as attending graduate school or experiencing financial hardship.
  • Student loan forgiveness — Currently, there are some student loan forgiveness programs available to federal student loan borrowers. If you meet certain qualifications, such as working in the public sector for a specific amount of time, your student loans may be forgiven in whole or in part.
  • COVID-19 interest accrual — Because of the COVID-19 pandemic, many federal student loans aren’t accruing interest. Additionally, some students may not need to make payments on their student loans at this time. This relief is in place until Jan. 31, 2022.
  • Income-based repayment plans — If federal student loan payments are more than a borrower is able to pay each month, they may qualify to have their payments adjusted based on their income. In this type of arrangement, as the borrower’s income increases, so will the loan’s monthly payment. Some qualifying borrowers may also be able to have their federal student loan debt forgiven after 20 to 25 years of consistent payments.

Repayment plans and debt forgiveness on private student loans

Private student loans generally have similar repayment contracts as federal student loans. However, private student loans typically do not offer as many of the protections that federal student loans provide, such as student loan forgiveness or income-based repayment plans.

Each lender will have different repayment terms on private student loans. If you encounter difficulties when repaying your student loan, your lender may be willing to work with you to adjust your repayment plan. For people with a steady income and an acceptable credit score, options for adjusting your repayment plan may include refinancing for more favorable repayment terms or a lower interest rate.

Pros and cons of federal and private student loans

When it comes to financing your education, there are a number of pros and cons to consider for both federal and private student loans.

The pros of federal student loans:

  • Interest rates are fixed and may be lower.
  • A credit check is not required for the qualification process.
  • No cosigner is needed.
  • Interest on subsidized loans is paid by the federal government while attending school at least half time.
  • Income-based repayment options may be available to qualified borrowers.
  • Loan forgiveness programs may be available to qualified borrowers.

The cons of federal student loans:

  • Not everyone qualifies for federal student loans.
  • The amount you can borrow is capped at a predetermined amount.
  • Your parents’ income may be considered as part of the FAFSA application (depending on the situation, this may reduce the amount of the loan).
  • A late or missed application deadline may prevent you from qualifying for funds.

The pros of private student loans:

  • The amount you can borrow is not as limited as with federal student loans.
  • Students with higher credit ratings are rewarded with better terms, such as lower interest rates.
  • A private student loan may serve as a source of supplemental financing if you’ve reached your federal student loan cap.
  • Students who have dropped below half-time may still qualify.
  • Funds may be used for expenses other than tuition.
  • The application process may be faster and have an open-ended application period.

The cons of private student loans:

  • Interest rates are often higher compared to federal student loans and may not be fixed.
  • A cosigner may be needed for you to qualify, depending on your borrowing history or credit score.
  • Private student loans may not be as readily available to lower-income students compared to federal student loans.
  • Income-based repayment plans are not typically available.
  • Loan repayment is often less flexible compared to federal student loans.
  • Deferment, forbearance and grace period options are typically more limited than federal student loans.

Putting it all together

Although applying and qualifying for student loans may sound like an intimidating process, you may find yourself ahead of the class by doing your homework first. Because federal student loans often provide more protections for borrowers, students who qualify typically prioritize these loans first.

However, depending on your situation, you may need a combination of federal and private student loans to cover your expenses. Learning the differences between federal and student loans can help you decide what’s right for you. Whatever your situation, be sure to get the right information before making this important financial decision.

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