The Main Differences Between Federal and Private Student Loans


The Main Differences Between Federal and Private Student Loans

The following article about student loans was written by Jeff Gitlen and published on LendEdu on May 3, 2018. It is being presented here with permission from Andrew Rombach.

student loans

Figuring out how you’re going to pay for college? Congratulations – making it to this point is an accomplishment in and of itself. The fact that you are getting prepared for the financial questions of higher education means that you’re serious about your future.

Unfortunately, most of you will get hit with a massive reality check when you look at how much your preferred schools will cost us. If your family savings isn’t enough to cover four years of tuition, then you are most likely going to resort to some sort of financial aid.

For many students, savings, grants and scholarships don’t cover the full cost, so they need to turn to student loans in order to pay for college.

In general, there are two main types of loans that a student borrower has available to them.

The simplest federal student loans definition is a loan that is funded by the government and comes with more borrower-friendly terms and options. The basic private student loans definition is a loan that is funded by private lenders and typically comes with harsher terms.

Federal vs. Private Student Loans: The Different Types of Loans

Some of the first differences between federal student loans and private student loans become apparent when you look at the different offers available to borrowers. The federal government outlines multiple different loans for specific borrowers, while the private sector breaks it down differently. Either way, there are multiple sub-types of student loans within each category that borrowers need to carefully consider.

Types of Federal Student Loans

Direct Subsidized Stafford Loans

These loans are considered to have the friendliest terms to students. Only borrowers who fall under a certain financial need threshold can receive them. These are subsidized because the government pays off the interest during school until repayment starts. Here are a few more details:

  • Only available to undergraduate students
  • ​Eligibility and size of loan is based on financial need
  • Students pay no interest while they’re enrolled at least half-time or during the six-month deferment period after graduation. After, they must pay interest.

Direct Unsubsidized Stafford Loans

These are similar to the previous Stafford loan, but they are unsubsidized. These are more widely available to more students without the same financial need threshold, but the government doesn’t cover the interest payments before the repayment period. Here are more details:

  • Available to both undergraduate and graduate students
  • ​No financial need requirement
  • Students are on the hook for interest payments from start to finish. While they can choose to start paying interest until after the grace period, all interest is added to the principal balance at the start of repayment.

Direct PLUS Loans

Direct PLUS Loans are offered to the parents of undergraduate students or to graduate/professional students. A student’s parent or graduate student can take out as much as necessary to cover the cost of attendance. They are the only federal student loan program that takes into account applicant credit history.

  • Undergraduate students’ parents are eligible, as well as graduate or professional students
  • ​Loan limit based on cost of attendance
  • Must not have bad credit to be eligible

Perkins Loans

The Perkins loan program was discontinued at the end of September 2017, so they are no longer available. They are included in this list because there may still be borrowers with outstanding Perkins student loan debt. With the Perkins Loans program, the school itself is the lender, and low interest loans are offered to borrowers under a certain financial need threshold. Here are a few more details:

  • Payments made to the school or school’s servicer
  • ​Exceptional financial need has to be demonstrated
  • Program discontinued as of September 2017

Types of Private Student Loans

Private student loans cannot be broken down the same way as federal loans. There aren’t clearly defined programs from one source: the federal government. Instead, there are a wide range of options that are available through various different lenders and banks.

There are a few common denominators. First, they are not funded by the government which is obvious. Second, private student loan applications are subject to similar standards of approval as a typical credit application. This means that approval-decline decisions as well as the loan terms are based on an applicant’s (or a cosigner’s) credit history.

While federal loans can be broken down by program, private student loans are not so clear cut. Here’s a basic overview of what the private sector offers. At a high level, there are standard student loan options for undergraduate and graduate students. Additionally, some lenders do offer specialized graduate loans. You can find graduate loans meant specifically for students entering pre-med, law school, or other professions.

Qualifying for a Federal Loan vs. a Private Loan

Federal Student Loans

  • Applicants are approved after filing the Free Application for Federal Student Aid (FAFSA); there is no other application.
  • ​Loan offers are based on family income, expected contributions, and financial need.
  • ​The only time credit history matters would be if you are applying for a Direct PLUS Loan.
  • No cosigner is needed.

Private Student Loans

  • Lenders have their own loan applications as well as eligibility criteria.
  • ​Loan offers are based on credit history and income in most cases.
  • ​Other factors such as employment, school, or major may factor into your eligibility in some cases.
  • Unqualified borrowers may need a cosigner which are accepted on applications.

Applying for a Student Loan

Applying for Private Student Loans

In order to apply for a private student loan, the process really varies depending on which private lender you’re considering. Each bank, for example, has its own student loan application process. It typically involves an online application, a credit check, and other documents and information may be requested.

As mentioned earlier, you have the option of adding a cosigner to your loan application which may bolster your case for a private student loan. At any rate, you should check each individual private lender’s website to find out what their application process entails.

Applying for Federal Student Loans

For federal student loans, you must complete the FAFSA each year; it is necessary to be eligible for any federal financial aid for higher education. The application opens annually on October 1 and remains open for over a year afterwards. For the 2018-2019 school year, the window of completion is from October 1, 2018 to June 30, 2019.

It’s generally best to get the FAFSA done as early as possible. First, you want to avoid missing deadlines. Second, some programs have limited funding and require an early application (meaning don’t wait because it could be gone). Also, your school will most likely use your FAFSA results to determine your financial aid package – which is generally sent out to students in late winter or early spring.

The government will let you know what sort of financial aid, including student loans, you will be eligible for.

The Costs of Borrowing

Private Student Loan Rates

Private student loan interest rates are set by the lenders themselves, but they are all based on the market rate set by the US Treasury, the benchmark for loan products in the United States.

Looking at the industry as a whole, private student loan rates can range anywhere from as low as roughly 3.6 percent to as high as about 13 percent (maybe even higher depending on the lender). Keep in mind that the range of rates will vary by lender, and rates in general are always subject to change at a lender’s discretion.

While there is a rough range of possible rates outlined above, individual borrowers will know more about their interest rate during or after the application process. As mentioned previously, loan terms, including interest rates, are dependent on credit history and other criteria. In general, a creditworthy borrower may expect a rate closer to the low end, while a less creditworthy borrower may expect a rate closer to the high end.

Contrary to federal loans, private lenders usually offer both variable or fixed rates on their student loans, and these can have an impact on the cost of your loan. Variable-rate loans are typically offered at a lower APR. Additionally, these rates are subject to change with the market, so they could end up rising or falling over time. The other option is a fixed-rate loan. These are usually offered at higher APRs relative to variable-rate loans, but they do not fluctuate with the market after the loan is disbursed.

Federal Student Loan Interest Rates

Federal student loan interest rates are also based on the market rate, but they are set by the Federal government each year. Contrary to private loans, they are fixed-rate loans, so there is no fluctuation in APR during repayment. Since federal loans are broken out simply by program, it’s much easier to break down the interest rates. Here is a list of the current federal rates for loans taken out after July 1, 2017:

  • Direct Subsidized Undergraduate Loans: 4.45%
  • ​Direct Unsubsidized Undergraduate Loans: 4.45%
  • ​Direct Unsubsidized Graduate/Professional Loans: 6%
  • ​Direct PLUS Loans: 7%
  • Perkins: 5% (discontinued)

Origination Fees and Prepayment Penalties

Origination Fees

Federal student loans some with several different origination fees. Direct subsidized and unsubsidized student loans come with a 1.066 percent loan fee on loans disbursed between October 2017 and October 2018. Direct PLUS loans come with a fee of 4.264 percent if disbursed over the same time period.

Many private lenders advertise no origination fee. However, there are still some lenders that charge the fee as a percentage of the loan amount.

Prepayment Penalty Fees

There are no prepayment fees associated with federal student loans. Also, there are many private lenders who do not charge origination fees. However, there are still some lenders that do, but these will vary on a case-by-case basis.

Student Loan Repayment Options

Federal student loan repayment options are much more flexible compared to private student loans. In a broad overview, there are four category repayment plans.

The ten-year Standard Repayment Plan is the first default option; it involves 120 installment payments over ten years. The Graduated Repayment Plan is another option. Graduated repayment involves 120 payments over ten years, but payments start low and gradually increase over time. The Extended Repayment Plan entails 300 installment payments over 25 years, and the borrower can choose a standard or graduated repayment schedule.

Finally, there are four different income-driven repayment (IDR) plans: income-based repayment (IBR), income-contingent repayment (ICR), income-sensitive repayment, Pay As You Earn Repayment (PAYE), and Revised Pay As You Earn Repayment (REPAYE). All of these plans base monthly payments off of discretionary income, and repayment terms vary from 15 to 25 years. If eligible, some borrowers can have their remaining balances forgiven after the repayment term is up.

Private student loan repayment options are nowhere near as flexible. The industry standard is the ten-year repayment plan – 120 installment payments over ten years. Throughout the industry, student borrowers can find lenders offering repayment terms from five to 15 years.

Federal vs. Private Student Loans: Which is Better?

Federal student loans are the clear winner here – they are available, have interest rates that are better geared to college students who are new to credit, a six-month grace period and deferment options, flexible repayment options, and other benefits and protections.

Private student loans can be reasonably priced, but they will generally come with a double-digit interest rates for new-to-credit borrowers. You or a cosigner must have a strong credit history to be considered, and there are fewer protections and benefits.

Try to get federal student loans first, then only turn to private sector lenders as a last resort to cover any remaining expenses.

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