Private Vs. Federal Student Loans: What’s The Difference?

Getting accepted into college is probably one of the most exciting things that can happen for your child, and one of the most stressful, but still exciting, events for you. This is the first step into a completely different chapter in both of your lives. You know you have to pay for it somehow, and for many people that is with student loans. Should you go with a federal student loan or a private? What is the difference anyway?

The biggest difference between federal and private student loans is that a federal loan is government-funded and offered by the U.S. Department of Education. A private student loan is offered by a credit union, a bank, state agency or school.

College is expensive

Federal loans

Since it’s best to start out with the federal loan option, the first thing you should do is complete the FAFSA (The Free Application for Federal Student Aid). This is required if you are applying for any kind of federal aid. Schools also use this to determine who is eligible for their institution’s financial aid, grants or work-study program. You will have to provide information regarding household income, W2s and tax returns, money in your checking and savings accounts and more. It’s a good idea to start gathering all these documents ahead of time. For more details regarding the FAFSA, visit https://studentaid.ed.gov/sa/fafsa.

Federal loans offer competitive fixed interest rates, different repayment options, and offer a grace or deferment period in which you do not have to make payments on the loans for six to nine months after graduation. The grace period is really nice because it gives the student a chance to acclimate to life after college before they start making payments. Eligibility for federal loans is based on the information provided in the FAFSA.

Applying for FAFSA Federal Aid

There are 4 types of federal loans:

Direct Subsidized Loans. These loans are for undergraduate students and are based on financial need. The school will determine how much you are eligible to borrow. The Department of Education will also pay the interest on these loans while the student is still in school.

Direct Unsubsidized Loans. These loans are not based on financial need and instead are based on the cost of attendance and other financial assistance you receive. The borrower is responsible for paying the interest on these loans, and if they decide not to pay it until the grace period is over, the interest will accrue on the principal.

To be eligible for these loans, the student must be enrolled at least part-time. These loans are granted to the student per academic year and have a limit to the amount of funding that can be borrowed each year.

If you are granted these loans, you will see them in your financial aid award package after you complete and submit the FAFSA. These loans will be in the student’s name and you can choose to accept or deny them.

Direct PLUS Loans. Direct PLUS Loans are for graduate or professional students and for the parents of undergraduate students who are enrolled at least part-time. If you are a parent taking out a Direct Parent PLUS Loan, you will be the primary borrower and the loan will be in your name. You must also have a credit history in good-standing. You are allowed to borrow the cost of attendance minus any other financial aid received.

Direct Federal Perkins Loans. These loans are granted to students who have extraordinary financial need and often come with lower interest rates. This loan differs from the above three because instead of the Department of Education being the lender, the school is the lender. Payment on this loan will be made to the school itself. Because of this, the amount you are allowed to borrow depends on the amount of funds available at the school, your financial need and the amount of aid you have already received.

College expenses

Private loans

Private loans are a way to fund the gap of what is left after you’ve applied all other resources, such as: college savings, work-study, scholarships or federal financial aid.

The reason you should start with federal aid is because private loans usually have higher and variable interest rates, making them more expensive and sometimes riskier. Some of the time, the borrower must start repaying the loan while the student is still in school. There are many things to consider when choosing a private lender.  Is the rate variable or fixed?  What is the floor (how low the rate can go) and the ceiling (how high the rate can go) of the loan.  Is the rate based on Prime or Libor? Is repayment deferred until after graduation?  Not every loan is the same, so be sure to do your research before saying no way or even jumping in with two feet.

Private loan eligibility is heavily based on credit. Since they are taken out by the student themselves, and most 18-year-olds don’t have enough credit to prove their creditworthiness, they will need a credit-worthy co-signer.

College weigh down

All in all, here are the big differences between federal student loans and private student loans.

Federal

  • Low, fixed interest rates
  • Various repayment options. You can choose the term of the loan, be it 5, 10, 15, 20 or 25 years. Interest rates will change depending on the term, but the choice is yours.
  • An income-based repayment option. You may be eligible for certain repayment options depending on your income.
  • A deferment period in which you do not have to make loan payments until six to nine months after graduation.
  • Four different loan options that may fit your situation.

Private

  • Higher, variable interest rates. Interest rates can also vary depending on the borrower and co-signers credit scores and history. But, that doesn’t mean they won’t rise as time goes on because they are variable.
  • May not offer a grace period. The student may have to make payments while attending college.
  • Various repayment options with some lenders.

Student loans can be confusing waters to navigate, but there are tons of resources out there for you. Contact your college to ask for more information or visit the federal student aid website: https://studentaid.ed.gov/sa/ to research private loan lenders in your area.

Also, don’t be afraid to ask other parents and students who have already gone through the process. I am sure there are tons of things they wish they did differently or other options they could’ve explored. Or, they may be so happy with what they did, it would be a good idea for you to do the same. Do some research and educate yourself. The more you know, the better off you’ll be!

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