Private vs Federal Student Loans: What's the Difference?

Private vs Federal Student Loans: What's the Difference?

With so many options for college financing, each with unique terminology, information, and terms, it’s no wonder that people become confused. Take private vs. federal student loans as a primary example. While both of these help people earn a degree, they work in very different ways. With the information provided, people will have a much easier time determining which one of these is right for their specific situation.
Whether you’re a student getting ready for college or the parent, student loans are probably top of mind. We’ll help you determine one of the biggest questions: private vs federal loans.

A Brief Introduction to Student Loans

With the cost of a college education on the rise, an increasing number of people are searching for ways how to afford school. After all, having a degree puts them in a better position to secure a well-paying career. However, before enjoying all the benefits of education, they must first determine how they’ll pay for tuition, books, lab time and other expenses that come along with college.

CHECK YOUR STUDENT LOAN REFINANCING OPTIONS

In simple terms, private student loans are those offered through banks, credit unions and other lending institutions. Often, people will first try to get a scholarship or secure a grant, which is fine. If that isn’t enough to cover everything, they can then look at the private loan option. In most instances, the lender pays the borrower directly. That means if people go this route, they have the sole responsibility of paying the money back. In comparison, federal student loans come from the US government.

Private Student Loans

Typically, students pay more in interest when securing a private student loan, even with excellent credit. However, they have the freedom of applying through whatever lending institution they want. Along with money for tuition and books, people can use the borrowed money for other college-related expenses. These include room and board, transportation and even a computer.

For many people, private student loans make sense. The reason is that they come with several benefits. For example, the application process is quick and easy. In fact, most lenders now have online portals, allowing people to apply for a loan via the internet. If someone needs a cosigner for the loan, most lending institutions have provisions for that. Not only is there a chance of getting a tax deduction on the interest paid, but seldom is there a prepayment penalty if the borrower pays the loan off early.

Along with the positive aspects of a private student loan are a few drawbacks. Again, students can expect to pay higher interest than they would on a federal student loan. Applicants must also have sufficient credit for a lender to approve the application. For some young people, this is a problem. It’s not that they have bad credit, just not enough good credit.

Federal Student Loans

Federal student loans have backing from the US federal government. These loans work specifically to help students, as well as parents, pay for the cost of a college education. As for qualifying, an individual must first fill out and submit a FAFSA. This acronym stands for Free Application of Student Aid, a form mandated by the US Department of Education.

Once submitted, this same entity of the federal government determines the “Expected Family Contribution” or EFC. In other words, the Department of Education uses the information provided on the FAFSA form to see how much a family would need to pay for a student’s college education.

One perk of a federal student loan is that students have different options.

  1. Perkins Loan – this particular loan is specifically for people with low income or very few assets. As far as qualifying, it comes down to both the student’s needs and the availability of funds for the college they want to attend. A few key benefits include a low fixed interest rate, no fees for taking out the loan and an extended grace period before the borrower needs to start making payments.

  2. Direct Loan Program – another type of federal student loan is the William D. Ford Federal Direct Loan Program. Of all federally backed loans, this is by far the largest. Under this umbrella are four distinct loans that include the Direct Subsidized Loan, Direct Unsubsidized Loan, Direct Consolidation Loan and Direct PLUS Loan. A few of the benefits include no credit check required, low fixed-rate interest, no prepayment penalty, and flexible repayment terms.

  3. Direct PLUS Loan – this loan is actually for parents who have children in college rather than based on a student’s financial need. Depending on the scenario, parents can borrow the full amount required to send their child to college. It also has flexible repayment options and low, fixed-rate interest. Unlike some of the other loans, parents must pass a credit check with this one. Otherwise, they would need an endorser or cosigner to receive approval. Also, the loan only covers one academic year. Because of that, they must reapply each year for additional funds.

  4. Direct Consolidation Loan – rather than an initial type of federal student loan, this works by helping borrowers repay their original loan through the government.

Repayment Terms

When it comes to repayment terms, private student loans don’t give students as many options as what they would get with a federal student loan. For instance, if someone takes out a government-backed loan, they don’t have to start paying the money back until after graduation. With a subsidized loan, the student doesn’t have an accruing interest rate while still in school or during the grace period following their graduation.

Something else to consider is that with a federal student loan, the amount a student has to pay each month depends on income. There’s even a chance of someone qualifying for a loan cancellation after a 20- to 25-year period. Students can also have a federal loan deferred if needed. Now, some private lenders do offer this, but they’re few and far between.

Which Is Better - Private Vs Federal Student Loans?

It all comes down to the student and what they need financially to attend college. However, the preferred college also plays a slight role in the decision-making process. The best thing a person can do is to sit down with a financial advisor to go over both options in detail. Obviously, people want the money necessary to attend college but without it putting them in serious financial debt.

For many students, the most obvious choice is a subsidized federal loan. Used by undergraduate students, the government determines how much a person needs, excluding any contribution from the family, as well as other financial aid. Since subsidized federal loans do not accrue any interest while attending college at a minimum of half-time or during deferment periods, these loans have an advantage.

The good news – for someone who thought getting a college education wasn’t in their future, there are viable options available.