Federal vs Private Student Loans for College
August 14, 2019
Paying for college is pricey and not every family has money stashed away. Once you’ve exhausted all your options through grants and scholarships, you may need to turn to student loans to fill in funding gaps. But the types of loans you go after aren’t all created or managed the same. It’s important to know the difference between federal student loans and private loans.
If you need to take out loans to pay for school, you should take a look at the key differences in federal vs. private student loans before applying for them.
Federal student loans vs. private student loans: what’s the difference?
Both types of loans offer students temporary funding assistance to pay for the college or university they’ll be attending.
Federal student loans come from the U.S. Department of Education. Private student loans come from private institutions, like banks, credit unions, and online lenders.
In general, federal student loans should be your first loan choice. They tend to have lower interest rates that are set by Congress and offer more protections and benefits to you, the borrower.
Federal student loans: the basics
To qualify for federal student loans, you’ll need to complete the Free Application for Federal Student Aid (FAFSA). After grants, scholarships, and other aid is awarded, the federal government will determine how much you can receive in federal loans. There are a few different types of federal student loans you may qualify for.
- Direct Subsidized Loans: These are loans that you can get if you demonstrate financial need as an undergraduate student.
- Direct Unsubsidized Loans: These loans are available to any type of student and aren’t based on financial need — anyone can receive them.
- Direct PLUS Loans: These are available to graduate and professional students, as well as parents of undergraduate students, to pay for education expenses that aren’t covered by other aid. You don’t need to show financial need to qualify, but a credit check will be done. The interest rates and loan fees for PLUS loans tend to be significantly higher than for subsidized and unsubsidized loans.
- Direct Consolidation Loans: These types of loans are available to consolidate all your existing federal loans into one loan with one monthly payment. This is usually done after graduation.
Federal student loans have interest rates set by Congress. You’ll keep that rate for the life of the loan — even if interest rates increase or decrease for future students. Most federal loans have a grace period, allowing you to start paying your loans back six months after graduation, instead of right away.
If you’re struggling to pay your federal loans back, you may qualify for alternative repayment plans, including:
- Income-Based Repayment (IBR): Your monthly payments are based off of 10 percent or 15 percent of your discretionary income. The payments are restructured every year based on your income and family size. Any balance left over after 20 or 25 years is forgiven.
- Pay As You Earn (PAYE): Your payments are 10 percent of your discretionary income and based on your income and family size. As with IBR, those details need to be updated annually. Balances are forgiven after 20 years.
- Revised Pay As You Earn (REPAYE): Monthly payments will be 10 percent of your discretionary income and remaining balances will be forgiven after 20 or 25 years.
- Income-Contingent Repayment (ICR): Your payments will either be 20 percent of your discretionary income or the amount you would pay over 12 years, adjusted for your income (whichever is less). Remaining balances are forgiven if you haven’t paid it off in 25 years.
The type of alternative repayment plan you qualify for is based on the type of loan or loans you have, what you earn, and your family size. The longer you wait to get on an alternative plan, the longer it will take to pay off your student loans. You should also know that any balance forgiven at the end of these repayment plans may be subject to taxation.
You may also qualify for deferment or forbearance, which allows you to temporarily pause your payments. Federal deferment and forbearance policies are generally more lenient than those offered by private lenders.
Private student loans: the basics
If you’ve exhausted all your federal student loan options and still need to fill in some funding gaps, private student loans may be a good option.
These loans can be offered by banks, credit unions, or other private institutions, like online lenders. Private lenders will do a credit check to determine your rates and eligibility, which might be difficult for new borrowers,such as college students. Most students will likely need a cosigner, like a parent or other relative with a strong credit history, to cosign on their loan.
Private student loan interest rates vary by lender. They’re calculated based on your credit score (or your cosigner’s), and by other factors like income and even the type of degree you are pursuing. This is to ensure you are likely to have the money to pay the loan back. All of the private lenders Purefy works with offer similar same grace periods to federal student loans.
Other major differences between federal student loans vs. private include:
Loan forgiveness: federal student loans have plans in place to help many people get their loans forgiven, either based on their job or how long they’ve been paying off the loan. Private student loans don’t offer forgiveness.
Consolidation: Only federal student loans qualify for a Direct Consolidation Loan. But both federal and private loans can be refinanced. Refinancing is when you take out a new loan to pay off your old loan, and then start making payments to your new one. If you refinance, your credit will be checked and if you don’t qualify for a lower interest rate, it might not be worth it. Private student loans don’t have the same set of alternative repayment options as federal loans.
Payment pauses: Federal student loans have great options for deferment and forbearance. Most private student loans offer options for in-school deferment or forbearance, but their offerings generally aren’t as flexible as the federal government’s.
Fees: All the types of federal loans discussed in this article come with a loan fee that is deducted from your loan disbursement. In the case of PLUS loans, this fee can be sizeable. In comparison, most private lenders (and all the private lenders in Purefy’s rate comparison tool) have no origination fees.
Federal vs. private loans: which one is right for you?
Overall, federal student loans should be your first loan choice due to their competitive rates and strong borrower benefits. But if you’re coming up short, you may need to tap into other resources, like private student loans.
Use Purefy’s rate comparison tool to see which rates and lenders work best for you. Not all lenders offer the same interest rates, so you’ll need to do a bit of homework first using our free tools to find the best one.