Federal Versus Private Student Loans

Planning & Saving
on September 19, 2013

Funding college tuition, books and housing often requires that students fill in financial gaps with a student loan. They have the choice of federal or private loans, which originate with the U.S. government or private banks, respectively.

Federal Loans
Students can qualify for three types of federal student loans:

  • Stafford – These loans disbursed by the federal government directly or through a private lender. Subsidized Stafford loans have the lowest rate of interest. They do not accrue interest until the student leaves college.
  • Perkins – The U.S. Dept. of Education guarantees these loans. The money is paid to the college, which distributes the funds.
  • PLUS – These loans are similar to Stafford loans but do not have grace periods for interest or repayment.

Differences in Loan Terms
When it comes time to repay student loans, federal loans are more generous than private loans obtained from a lending institution:

  • Interest rates are typically fixed for federal loans whereas many private loans set a variable rate that can increase the monthly payment.
  • Private loans usually have a higher rate of interest than federal loans.
  • There are fewer options with private loans to adjust payments if they become unaffordable at a later time.
  • Federal loan interest can be deducted from income, but private loan interest cannot.
  • Loan forgiveness after 10 years is possible for federal loans for students who enlist in certain public service programs such as the Peace Corps. No such option exists for private loans.
  • Private lenders use their own underwriting process to determine loan eligibility that typically includes checking credit history of the student and any co-signer.

Borrower Protections
Federal student loans have significant protections for borrowers throughout the life of the loan:

  • Besides loan forgiveness for public service, borrowers may apply for a postponement, consolidation or forbearance of loans if the student’s income is insufficient to make monthly payments. Private loans offer no such protections.
  • If the borrower dies or acquires a permanent disability, a federal loan may be canceled.
  • There is no prepayment penalty for federal loans, but many private lenders charge such a fee.

RELATED: Financial Aid 101

When a Private Loan Makes Sense
Clearly, compared to federal student loans, funding a college education with private loans is not the best option. Sometimes, however, the gap between a student’s resources and the costs of an education require more than what can be obtained through federal loans. In this case, a private loan may be a good last resort especially if the student’s field of study guarantees a job with sufficient income to meet the payments.

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