Federal vs. Private Student Loans for College
Student loans are divided into two major categories—federal and private—and each category has smaller subcategories within it. But, while federal and private loans are different in many ways, all loans have one big thing in common: you’re responsible for paying back your loan (plus interest). This makes student loans less desirable than other forms of financial aid like grants and scholarships, but still a valuable option in paying for school.
How are Federal and Private Student Loans Different?
Private and federal student loans are different in several key ways, which will greatly impact your financial health, both now and in the future:
Source of funding
Federal loans are funded by the U.S. Department of Education, while private loans are funded by private institutions. This means that you will apply for a federal loan by filling out your FAFSA but apply for a private loan through the bank, school, state, or online lender of your choice.
Interest rates for private loans vary based on you or your co-signer’s credit score, whereas federal loans have a flat interest rate set by Congress. Generally speaking, if you or your co-signer has a good credit score, private student loan interest rates will be lower than federal interest rates. If your credit is not so great, then the rates would be higher with a private student loan. Federal student loans do not even consider credit score.
Federal loans offer flexible repayment terms such as income-based payment plans, where private loans usually do not. Federal loans usually offer a grace period, while with a private loan, you’ll typically need to start repayment right away.
Federal loan programs sometimes offer forgiveness after a number of years in certain public service career fields. Private student loan forgiveness options are very limited.
If you qualify for a Subsidized Direct Loan (based on financial need), the government will help pay the interest on your loan. Subsidies are not available with private loans.
Federal student loans have more eligibility requirements than private loans, and access to some federal loan programs is limited by financial need. Federal student loans are also limited in how much you can borrow each year and overall, while private loans have fewer limitations and allow you to borrow more.
When to Choose a Private Loan
When federal loans offer many benefits over private loans, it may seem unwise to take out private loans for college. But that isn’t always the case.
A private loan is a good choice if
- You’ve already filled out your FAFSA to see if you qualify for grants and other financial aid;
- You’ve applied for outside scholarships;
- You’ve borrowed the maximum amount in subsidized and unsubsidized federal loans or you don’t qualify;
- You have a cosigner with good credit or have a good credit score yourself and can benefit from the lower interest rates;
- You have a budget and know how much you need to borrow.
Applying for a Private Student Loan
Applying for private loans for college is a pretty quick process. Usually, there is an online portal you go through and the application process takes anywhere from 10-30 minutes. You also want to make sure you really need a private loan, and that you’re getting the best possible deal, before you sign on the dotted line.
Talk to Financial Aid About Private Student Loans
Most lenders will require you to get a form from your financial aid office certifying that you need additional aid to cover your cost of attendance (COA). This can also help you gain more confidence that you need to pursue private loan options, before moving forward.
For any type of private loan, the first step towards applying is speaking with your school’s financial aid office.
The Best Private Loans For College Students
Compare the Best Private Loans For College Students
We compiled a list of the best private student loans available on the market for college students
What to Watch Out For
One of the downsides of private loans for college is that they’re usually offered by for-profit institutions, which are subject to fewer regulations than the U.S. Department of Education. Federal student loans are more predictable and uniform, whereas private loans can vary a great deal from bank to bank. Make sure you read the details of the master promissory note.
This means that when you’re shopping for private loans for college, it’s especially important to read the fine print. Make sure you’re aware of these details when you’re comparing loans.
Advertised vs. Real Rates
While the U.S. Department of Education is prohibited from advertising their loans, private lenders are permitted to do so, and they often create eye-catching ads to gain student borrowers’ attention.
Remember that lenders’ advertised interest rates usually apply only to the most qualified borrowers (those with the highest credit scores) and may not apply to you.
Look beyond the ads to find the real interest rate you would receive with your credit score (or your cosigner’s credit score) with several different lenders, and compare.
Variable vs. Fixed Rate
Even when you dig down past the advertisements to the interest rate you can really expect with your or your cosigner’s credit score, you need to look at one more detail: whether the interest rate is fixed or variable.
Many private student loans come with a variable interest rate, which means the rate can increase at any time, with little to no warning. What may look like the best interest rate out of the bunch may actually turn out to be the worst because of a variable interest rate. You can always take a variable rate for now if the savings are great enough, and refinance your student loans at a later date with a fixed rate if you feel like interest rates are on the climb. Just make sure there is no prepayment penalty on the private student loan so refinancing to lock-in doesn’t cost you any money.
Another detail to be aware of with private loans for college is borrower protections. With federal loans, these protections are regulated by the federal government. With private loans, you must act as your own advocate.
Read over what each lender offers in terms of deferment and forbearance, as well as repayment options. For example, you may or may not have the option to choose the length of your term, meaning you can choose to pay off the loan faster, with less interest, or take more time to pay the loan back while accruing interest.
Most private lenders consider your credit score when offering a loan. The higher your credit, the better your interest rate will be, and the more you may be able to borrow. But different lenders have different requirements when it comes to credit. If you need a co-signer, check to see if the lender has a co-signer release after a certain set period of on-time payments being made.
Undergraduate borrowers are less likely to have established credit or income, so lenders often allow students to apply for loans with a cosigner. Some lenders also at career path and income potential when a cosigner isn’t available.
Choose the Right Private Loans for College
Before considering any loan it’s important to understand exactly how student loans work. Once you are comfortable and you know what you are getting into, then it’s important to consider whether or not a private loan for college makes sense for you. We still think that despite the high cost of education, college is still worth it.