When you’re figuring out how to pay for college, the options may seem overwhelming or confusing. You’ll hear about federal loans, receive advertisements for private loans and wonder how to make the right decisions about how much to borrow and from which lender.
A good first step is to learn about the differences between federal and private student loans, including which option might be best for you as an undergrad, a graduate student or even as a parent.
[Read: Best Private Student Loans.]
What Are Federal Student Loans?
A federal student loan is money you can borrow from the federal government and then repay with interest to help cover your education costs at eligible schools. The Department of Education issues these loans under the William D. Ford Federal Direct Loan Program. The department owns about 92% of U.S. student loans, according to MeasureOne, an academic data firm.
Four types of direct loans are available:
— Direct subsidized loans help undergraduate students based on financial need, and the amount is determined by the school. These loans have the lowest interest rates, and overall costs are low because the federal government covers the interest during and just after college.
— Direct unsubsidized loans are available to undergraduate and graduate students, also at an amount set by the school, with no requirement to show financial need. Interest accrues on these loans immediately, although you don’t have to begin making payments until six months after your studies end. Unsubsidized loans have higher interest rates than subsidized loans for graduate or professional students.
— Direct PLUS loans are loans for graduate or professional students or parents of dependent undergraduates. The maximum PLUS loan amount you can receive is the cost of attendance — determined by the school — minus any other financial aid. These loans carry higher interest rates and a higher disbursement fee than subsidized and unsubsidized options, and they require a credit check.
— Direct consolidation loans allow you to lower your monthly payments and access forgiveness programs by combining your eligible federal student loans into one loan with a single loan servicer.
Pros and Cons of Federal Student Loans
Pros:
— Typically no credit checks. Most federal student loans, except for Direct PLUS loans, do not require a credit check, making them a good choice for students with no credit or bad credit.
— Postponement options. Federal loans allow you to defer payments in some cases and enroll in forbearance programs if you’re having trouble with repayment.
— Income-based repayment plans. You have the option of signing up for one of four income-driven repayment plans, which could limit payments to 10% to 20% of your discretionary income.
— Access to student loan forgiveness programs. You may be eligible to have some portion of your loans forgiven through the Teacher Loan Forgiveness or Public Service Loan Forgiveness programs. You may also qualify for forgiveness due to other circumstances, such as a total and permanent disability or school closure.
— Often lower interest rates. Federal student loans come with fixed interest rates that are generally lower than private student loans.
Cons:
— Loan limits. The annual limit ranges from $5,500 for some undergrads to $20,500 for graduate students, depending on the type of loan. Lifetime limits also apply. If the loan doesn’t cover your cost of attendance, you will need to bridge the gap with other sources of funding.
— Origination fee. All federal student loans come with an origination fee, which is subtracted from your loan funds. The fee starts low for undergraduate students but increases for graduate and professional students as well as for parents.
— Can’t choose a loan servicer. When you take out a federal student loan, the Department of Education assigns a loan servicer to your account. If you have a negative experience with your loan servicer, you have few options for switching.
[Read: Best Student Loan Consolidation and Refinance Companies.]
What Are Private Student Loans?
Private student loans can also cover the costs of education, but they’re issued by banks, credit unions and other lenders. Students typically turn to private student loans when federal loans won’t cover all of their costs.
These loans usually offer a choice between fixed and variable interest rates, and repayment terms between five and 20 years. Borrowers must pass a credit check to qualify — but because most college students don’t have enough credit history to take out a large loan, a parent will likely need to co-sign.
Pros and Cons of Private Student Loans
Because federal student loans come with more borrower protections than private loans, maximize your federal options first. But if you need to use private student loans, consider the advantages and disadvantages before borrowing.
Pros:
— Higher loan amounts. Loan limits vary with each lender, but you can typically borrow up to the cost of attendance. Some students go this route when federal loans won’t cover all of their school expenses. However, a clue that someone may be overborrowing “is if they cannot obtain enough federal student loans to pay for their desired school,” says Scott Stark, a certified financial planner at Financial Finesse.
— Potentially low interest rates. The interest rates on some private student loans are lower than rates on federal loans for those who qualify. You’ll typically need excellent credit to get the best rates, though. If you wind up with a high interest rate, you may be able to refinance later, Stark points out.
— No upfront fees in most cases. Private lenders typically don’t charge application or origination fees, which helps you save upfront.
Cons:
— No loan forgiveness programs. Private lenders generally don’t offer programs that forgive your debt after meeting certain requirements, as you may be able to use with federal student loans.
— No guaranteed hardship options. Private lenders also typically won’t offer income-driven repayment plans. Some may have forbearance programs if you’re struggling financially, but these may not be as flexible as what you’d find with federal loans.
— Lenders require credit check. Most private student loans are based on the applicant’s credit. If you haven’t had a chance to build credit, you may not be able to qualify without a co-signer.
Differences Between Federal and Private Student Loans
| Federal student loans | Private student loans | |
| Loan limits | Lifetime limit of $31,000 for most dependent undergraduates and $57,500 for independent undergraduates; graduate and professional students can borrow up to $138,500 total, including all federal undergraduate loans. | Usually 100% of the cost of attendance, calculated by the school. |
| Interest rates | 4.99% to 7.54% fixed annual percentage rates for direct loans taken out between July 1, 2022, and July 1, 2023 (temporarily lowered to 0%). | Vary; average fixed APRs range from 3.22% to 15.32%; average variable APRs range from 1.79% to 15.95%. |
| Origination fee | 1.057% for direct subsidized and unsubsidized loans; 4.228% for Direct PLUS loans. | Vary. |
| Approval process | Fill out a FAFSA form; no credit check needed to qualify unless you’re taking out a PLUS loan. | Fill out an application through the lender; credit check typically required. |
| Repayment plans | You can defer payments while enrolled at least half-time and immediately after graduation. Then you can enroll in one of eight repayment plans, including four that are tied to your income. | You may have a choice between deferring payments; paying interest-only while in school; making partial payments in school; and starting principal and interest payments right away. |
| Extra support | Deferment and forbearance programs; income-driven repayment plans; forgiveness and discharge options. | Private borrowers might offer some forbearance programs, but they aren’t guaranteed. |
[Read: Best Student Loans Without a Co-Signer.]
How to Choose Between Federal and Private Student Loans
If you’re trying to decide which loan type — federal, private or a combination of both — is best for you, start with the cost of each, both in the short term and for the life of the loan. Federal loans are generally going to be more affordable and accessible for borrowers.
“Private loans are considerably less flexible than federal,” Stark says. “If private loans are necessary to afford school, consider a less expensive institution or find alternate funding. The exception is when entering an incredibly selective field where the alma mater can make or break future job prospects.”
No matter which type of loan you take out, you will need to consider what you can afford. One rule of thumb: “You don’t want your total student loan debt to exceed the first year’s salary in your field,” Stark says. “This can help you calculate what the debt ceiling should be for your situation.”
To figure this out, “Consider your career and salary trajectory,” says LeAndra Ross, a regional director at the AccessLex Center for Education and Financial Capability.
A loan calculator can help you determine monthly payments based on loan size, and your school can provide information about the average starting salary for your degree, Stark says. Or, you can use a tool such as Payscale or the Bureau of Labor Statistics to estimate your earnings.
Based on your potential salary after graduation, consider whether you can handle those monthly payments. Also, think about whether you’d like access to flexible repayment plans and loan forgiveness programs, Ross says.
[CALCULATE: Use Our Free Loan Calculator to Estimate Your Monthly Payments.]
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Private Student Loans vs. Federal Student Loans: What?s the Difference? originally appeared on usnews.com
Update 04/03/23:
