Federal vs Private Student Loans: Which One Is Best For You?

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Federal and private student loans are meant to help students finance their college or graduate education. In this article, we’ll compare federal vs private student loans. We’ll cover their key differences, such as the amount of money you can borrow and their eligibility requirements.

We’ll also see why either of them may be preferable to the other, as well as how different their repayment, interest rates, and assistance programs are. Ultimately, this article should help you choose which loan to take. Read on!

Federal student loans vs Private student loans – Features

You can use both federal and private student loans to finance your education. Each of them has unique features you should know about before you decide which one you need.

Federal Student Loans

The most common federal student loan definition describes them as any loan or financial aid coming from the federal government.

You use the money to fund your college education. They often have more benefits than other types of loans, although borrowers often use them in tandem with private loans.

Who qualifies for federal student loans? The federal government imposes eligibility requirements that dictate who can get a federal loan. Generally, though, you can qualify for this loan if you:

  • Demonstrate that you have financial needs
  • Are a US citizen or a permanent resident
  • Are enrolled as a regular student in an eligible degree or certificate program

On the flip side, you can be disqualified for federal student loans for a number of reasons, such as not making satisfactory academic progress or defaulting on existing federal loans. If you’ve ever been incarcerated, you can also be denied the loan.

There are two main types of federal student loans, namely:

  • Subsidized federal student loans are loans for eligible undergraduate students who have a financial need to cover the cost of college or further education.
  • Unsubsidized federal student loans are those that are given to students whose eligibility isn’t based on financial need.

In subsidized loans, the federal government pays the interest while you’re in college or when the loan is deferred. Meanwhile, in unsubsidized loans, interests start accruing as soon as the loan is taken out.

Private Student Loans

The most common private student loans definition describes them as loans from private organizations given to students to fund their studies. These entities may be banks, credit unions, or other state-based or affiliated groups.

The best graduate private loans are those that offer better rates, higher loan amounts, and more flexible repayment terms compared to federal loans. However, on average, many nonfederal loans have higher APRs than their federal counterparts.

What are private student loans for and who is qualified to receive them? Similar to federal loans, you can use them to finance education costs. However, you must consider the following additional eligibility requirements:

  • A good credit score
  • A steady source of income
  • Enrollment in a qualified education program

Lenders need to be certain about your ability to pay, so they implement a minimum income and credit score requirement.

If you don’t meet these requirements, you may add a cosigner to your application — someone who meets the requirements on your behalf and who will take the responsibility of paying the loan in case you default.

How is a federal loan different from a private loan for education?

To compare these two types of loans even further, we need to look into more specific factors characteristic of each of them.

Repayment 

If we compare repayment plans for private vs federal student loans, it’s clear private loans can take more years to pay off.

Private loans have no set borrowing limit on how much you can borrow. They often cover the full cost of your attendance. As a result, your loans can cost higher or take a longer time to repay if you go to an expensive college or spend more years at school. Most private loans offer 20 to 25 years in loan terms.

Meanwhile, federal student loan limits are around $12,500 annually. They also don’t exceed $57,500 in total. The limits can rise to $20,500 annually and $138,500 in total.

Most federal student loans come with 10-year repayment plans plus a grace period of 6 months after graduation. You also have a few repayment options, which we’ll discuss in detail further.

Interest Rates 

Another key difference between federal and private student loans is the interest rate you pay. Private student loans often have higher interest rates than federal student loans.

Private lenders charge around 4.29% to 12.49% in fixed rates and 1.8% to 14.8% in variable rates. If you have an excellent credit rating or a cosigner with a good credit score, then you may get a lower interest rate.

Meanwhile, the federal government sets a range of rates for student loans for the upcoming academic year. For instance, interest rates for subsidized and unsubsidized loans for undergraduates from 2019 to 2020 were around 4.53%.

Subsidized Loans

Another key difference between federal vs. private student loans is the existence of subsidized loans. These loans are for students in need of financial help while paying for college. This loan is determined by your total cost of attendance minus the expected family contribution.

Credit 

In terms of credit requirements, federal loans are preferable over private loans because they don’t require any minimum credit score. Making federal student loan payments will also help you build credit. That’s one way that student loans do affect your credit score.

Meanwhile, nonfederal loans have credit requirements. Most private loan providers require a FICO score of 670 or higher. If you don’t have a credit score, you’ll need a cosigner who has a good or excellent credit record.

Cosigner 

Digging deeper into federal student loans vs private ones, you sometimes need a cosigner to help you take on a loan.

A cosigner is a person who has a stable income and/or good credit history that can help you pay the loan in case of default. Loans from the federal government do not usually require cosigners, but most private student loan providers, such as a bank or a credit union, may have this requirement.

Tax Deduction 

Student loans are tax-deductible. Thanks to student loan interest deductions, you can subtract all or part of the interest you pay on your loan when you file your annual federal income tax to the IRS. Eligible college loans for tax benefits include all federal loans and most private student loans.

Payment Options and Plans

When it comes to federal vs private student loans repayment plans, there are a variety of options to choose from.

Federal loans typically have 10-year repayment plans, and payment options include:

  • Standard repayment plan – you pay a fixed amount each month within 10 years
  • Pay as you earn – make monthly payments equal to 10% of your discretionary income
  • Income-based repayment – you pay monthly using 10%-15% of your discretionary income but no more than what you would pay under a standard repayment plan

Meanwhile, various private loan lenders have their own repayment plans. In general, payment options include:

  • Interest-only – you make interest-only payments for the first two years
  • Interest plus – make interest payments on top of your fixed monthly payments
  • Full principal with interest – repay the principal plus interest right away

Penalty Fee 

When comparing private vs federal student loans for grad school, it’s important to watch out for penalty fees.

Federal loans do not charge any penalty fees. If you pay the loan ahead of the expected loan term, there are also no prepayment penalties. Private lenders, on the other hand, may charge such fees depending on their policies.

Other fees to look out for are origination fees, application fees, and late payment fees.

Loan Forgiveness and Assistance Programs 

Another important difference in federal vs private student loans is the existence of loan forgiveness programs. With federal loans, there are ways you can be “forgiven” the loan you took on. These programs include:

  • Public Service Loan Forgiveness – for government or nonprofit organization-employed individuals. After making 120 qualifying monthly payments, you may have the rest of your loan forgiven.
  • Teacher Loan Forgiveness – forgives up to $17,500 of your federal loan if you teach full-time for 5 consecutive academic years in low-income schools or education agencies.
  • Closed School Discharge – be eligible for loan discharge if your school closes while you’re enrolled or soon after your withdrawal.

Loan forgiveness programs don’t exist in private loans in the traditional sense, although you can request deferment or forbearance.

Refinancing your private loan could also help lower your payments, especially if you use the best student loan refinance companies around.

At the same time, you may be able to consolidate federal and private student loans. You can apply for a new loan to pay off your original loans, and you’ll be given a lower interest rate. This can also help you decrease the time it takes to pay off the loan in full as well as lower the total interest you’ll pay throughout the loan’s life span.

Private Student Loans vs Federal Student Loans: Which Should You Choose?

Choosing between federal and private student loans can be tough. You may even have to use both of them, which is a prevalent trend based on recent student loan debt statistics. Here’s a quick overview of their benefits to help you make a decision.

What are the benefits of federal student loans?

Budget-conscious students generally prefer federal student loans because of the following advantages:

  • Fixed interest rate – most federal student loans for graduate school education charge fixed interest rates, so you don’t worry about paying higher or lower than your expected costs.
  • Lower average rates – any comparison of federal vs private student loans is incomplete without tackling the fact that federal loans have a lower overall average interest rate. That’s true for both graduate and undergraduate students. The average rates are 2.75% for undergraduates and 4.30% for graduate students.
  • Variety of repayment plans – federal student loans have flexible repayment plans that you can choose from. These plans help you pay the financial aid back faster.
  • Loan forgiveness programs – federal student loans also offer various loan forgiveness programs, which help you cancel or discharge your loan after making a certain number of payments.

What are the benefits of private student loans?

Although they’re meant to supplement federal student loans, the advantages of private student loans vs federal ones are also immense.

  • Higher borrowing limit – unlike federal student loans, which offer only a limited amount of money, private student loans cover the total cost of your attendance at university, making it a great choice if you’re studying at an expensive school or staying at school for many years.
  • Lower interest rates – although loans from the federal government or state agency usually have lower rates, the best private student loan providers offer competitive rates, too. If you meet certain eligibility requirements, such as having an excellent credit score and a steady income, you can get better loan terms and interest rates of as low as 3% to 3.5%.

Since both have their own advantages, the choice between federal student loans vs private student loan rates entirely depends on your particular situation.

Which one is right for you?

Federal and private student loans are helpful for anyone who wants to start paying for college or further their studies into a career school. Federal student loans have lower interest rates and offer the chance for federal government assistance and loan forgiveness. Meanwhile, private student loans help you cover the total cost of your attendance, effectively letting you borrow a higher amount of money. The interest rates for both types of loans are competitive, although private student loans (and among these, we count student credit cards as well) offer the chance to refinance and consolidate loans, which is helpful if you want to get lower rates and shorter repayment terms.

FAQ

What happens if you default on federal student loans?

Defaulting on federal loans can impact your ability to take out any future loans. You’ll lose your eligibility for deferment and forbearance, and it will reflect on your credit history. This can then lead to more serious consequences in the future since lenders view a negative credit history as something risky.

Can you consolidate private and federal student loans?

Yes, you can, although you can only do so using a private lender. You can apply for a new loan to pay off your existing federal and private loans (a strategy called refinancing), effectively consolidating all your loans into one payment. You may also get better rates in doing so.

Where to get private student loans?

You can get private student loans from private financial entities such as banks, credit unions, and other similar lenders. They typically offer larger amounts of money as well as longer loan terms for students. They also usually have higher rates and more refinancing options.

What happens if you default on private student loans?

In case of default, private student loan lenders seek repayment from your cosigner or demand immediate full payment. Your account can be sent to a collection agency. In some cases, the lender may also sue you or your cosigner. This is another huge difference between federal vs private student loans.

ABOUT AUTHOR

I learned a lot about finance after working for a digital marketing company specializing in investing and trading stocks, forex, etc. After that, I got exposed to other verticals such as wealth management and personal finance, which further improved my understanding of the financial world.

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