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Private vs Federal Student Loans: Major Differences You Need to Know

Once upon a time, private student loans were considered a far inferior option to federal student loans, because they were typically much more expensive. That’s not necessarily the case anymore. Interest rates on private loans may be lower than some federal offers and may come with perks such as help finding your first job. For instance, SoFi offers rates as low as 3.5% as an alternative to parent PLUS loans that can have rates over 6%. 

However, federal student loans still have far more options for lowering or eliminating payments in cases of economic emergency. Here’s what you need to know about the differences between private and federal student loans:

Income and Credit Qualifications Are Stricter for Private Student Loans

For the most part, federal student loans don’t have a minimum credit score or income qualifications. However, there is one exception—Federal PLUS loans issued to graduate students and parents. PLUS loans are loans beyond the basic ones offered directly to students to help cover the remaining cost of attendance to go to a particular college. Private loan lenders, however, will consider your income or that of your co-signer.

There are advantages and disadvantages to the income and credit qualification differences. For federal student loans, you don’t have to worry about minor credit issues preventing you from qualifying for a loan. A private loan may only let you borrow a few thousand, while federal PLUS loans generally for parents or graduate students could cover up to the cost of attendance.

You can borrow enough to cover textbooks, room, and board, tuition, etc. For instance, If your total cost for the year is $35,000 and your other financial aid totaled $10,000, your family could borrow $25,000 annually. That’s $100,000 over the course of four years. A middle-class family making $50,000 per year can get approved for that under federal lending but only $10,000 privately. The result may be looking for scholarships or picking a cheaper school.

A federal loan for undergraduate students has a maximum that varies annually from $5,500 to $12,500. The lower limit is for dependent first-year undergraduate students, while the higher number is for independent students or dependent students in their third year or beyond whose parents are unable to borrow PLUS loans. There are two types of federal loans within the loan limits are issued directly to undergraduate students: subsidized and unsubsidized.

Subsidized loans don’t charge interest while the student is at least a half-time student and some other special circumstances. The amount of subsidized loans available to a student max out between $3,500 and $5,500, depending on year of school. These are considered a type of aid that is based on family income reported on the FAFSA form.  Unsubsidized loans always incur interest and are available regardless of family income.

Repayment Options and Breaks From Payments Vary Quite a Bit

For the federal student loans, repayment options are the same no matter which servicer you pick. The standard repayment term is 10 years. You may qualify for payments based on your income if your income is too low for the amount of loans you have to pay and up to 25 years to pay off your loans. This isn’t the case with private student loans. One lender may require repayment within 5 years, while another lender may give you 10 or 15 years. Private lenders may or not require immediate beginning of repayment while the federal government generally gives 6 months after graduation.

The difference in repayment terms can mean hundreds of dollars per month, but the loans would be paid off faster. Less time to repay means less interest charged. The federal government guarantees allowed payment breaks when you experience a defined level of financial hardship. Whether a private lender offers such a program is optional and you have to read your contract carefully for restrictions. However, private lenders also have the optional perks such as free career counseling and networking that federal student loans don’t.

(See also: 4 Ways To Avoid Student Loan Scams)

Potential Forgiveness Is Restricted to Federal Student Loans

Private student loans can only be forgiven in the case of when allowed under bankruptcy, which is very rare. Public service loan forgiveness and most other programs you hear about are for federal student loans only. The main exceptions to this rule are employer-offered student loan repayment programs, programs where your employer agrees to pay a certain amount of your student loan back as a benefit to your employment.

For instance, you may be offered $5,000 towards your student loans for staying with your company for 5 years. Whether they repay both federal and private student loans is up to the lender.

(See also: What is Student Loan Forgiveness?)

Interest Rates Vary Among Private Student Loan Lenders, but They Can Be Cheaper

Traditional federal student loans issued directly to undergraduate students have low interest rates and all the repayment plans the federal government has to offer. However, parent or graduate PLUS loans may have double the interest rates that a private loan does. If you are offered an interest rate above 4% with fixed interest on any federal student loan, you can compare rates on sites like credible.com. You just will give up federal protections for forgiveness and reduced or limited payments for economic hardship situations.

There are variable rate loans, loans where rates can change up or down over the life of your loan, available through private lenders, but they aren’t worth the risk of a payment that can vary up or down up to hundreds of dollars. For instance, if your rate is variable, your interest rate could be 4 percent when you receive it and 7 percent 6 months later. The rates change based on the current economy. All private student loans will specify variable or fixed rates.

Private and federal student loans have a quite a few differences: repayment plans, financial hardship guarantees, and forgiveness opportunities. However, private student loans are a better option than they ever have been. Compare all your options and potential repayment plans when making borrowing decisions.

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