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Student Loans

What Is the Difference Between Private and Federal Student Loans?

A college education is an investment in your future, but it may be hard to afford without taking out student loans. Not all student loans are created equal, and they can take decades to repay. Before borrowing, make sure you have a complete understanding of your loans and their terms.

Broadly, there are two types of student loans: federal and private. Private student loans are made by private lenders, such as banks or credit unions, while federal student loans are made by the federal government. What type of loan you'll be able to borrow will depend on several factors, including your needs, year in school, income and how much you've already borrowed. Read on to learn more.

What Is a Federal Student Loan?

Federal student loans, also known as direct loans, are funded by the U.S. Department of Education (although a loan servicing company will handle your loan).

There are several types of federal student loans, including for undergraduate students, graduate students and students pursuing professional education. Each type of federal student loan has its own set of requirements; some are available only to students who have financial need, while others are offered regardless of need.

All federal student loan borrowers must first complete and submit a Free Application for Federal Student Aid (FAFSA) form. This application is used to determine if you're eligible for federal student loans; if not, you may need to look into private student loans.

To borrow money using a federal student loan, you must meet some basic eligibility criteria. For instance, you must be a U.S. citizen or eligible noncitizen; have a valid Social Security number; be enrolled or approved to enroll in an eligible degree or certificate program; be enrolled at least half time (for direct loans); and be making satisfactory academic progress. If you're male between the ages of 18 and 25, you must also be registered with the Selective Service.

Types of Federal Student Loans

Each kind of federal student loan has its own purpose, terms and qualification requirements.

Direct Subsidized Loans

Direct subsidized loans are available only to undergraduate students who demonstrate financial need. The main difference between a subsidized and unsubsidized federal student loan is that the federal government pays the interest on subsidized loans as long as you're enrolled in school at least half time, for the first six months after you graduate and during any deferment or forbearance period.

Direct Unsubsidized Loans

Direct unsubsidized loans are available for undergraduate, graduate and professional students. You don't have to show financial need to qualify for an unsubsidized loan. Unlike with subsidized loans, you're responsible for paying interest on unsubsidized loans at all times, even when you're enrolled in school.

Direct PLUS Loans

Direct PLUS loans are available for graduate or professional students, or for parents of dependent undergraduate students (these are called Parent PLUS loans). PLUS loans can be used for educational expenses that your other financial aid doesn't cover. Although borrowers don't have to demonstrate financial need to get a direct PLUS loan, they do need to undergo a credit check to see if they have an adverse credit history. If they do, they may still be able to get the loan, but will have to meet some additional requirements.

The federal government limits how much you can borrow in direct student loans, both annually and over the course of your undergraduate and graduate education. Loan amount limits vary depending on several factors, including the type of loan, your year in school and whether you're independent or are still considered a dependent.

What Is a Private Student Loan?

Private student loans are made by banks, credit unions and other financial institutions—not the government. You can apply for a private student loan at any time, but you should always complete the FAFSA first to see if you qualify for any federal student loans. In a contrast to federal student loans that may set parameters on how the money is used, private student loans can be used for whatever expenses you want.

Eligibility for private student loans depends on your income, credit history and credit score. The better your credit is, the better interest rate and loan terms you may qualify for. As a student who may not have a long credit history, having a parent cosign on your loan application may boost your chances of approval.

Differences Between Federal and Private Student Loans

There are some key differences between federal and private student loans when it comes to whether you'll qualify as well as how you'll repay the loans and how they'll accrue interest.

Income and Credit Qualifications

Approval for a federal subsidized student loan is decided in part by the borrower's financial need, which is determined by your family income as reported on the FAFSA. Borrowers with a greater financial need are more likely to be able to borrow a subsidized loan. Unsubsidized federal student loans, however, are offered regardless of your family income.

With the exception of PLUS loans and Parent PLUS loans, federal student loans don't require a credit check, so having minor credit issues won't prevent you from being approved for a loan. Private lenders, on the other hand, consider credit scores in weighing your loan application. If you have poor credit or (like many students) don't have much of a credit history, see if your parents can cosign the loan. If they have good credit, their signature can tip the scales in your favor. Just keep in mind that any missed payments on a cosigned loan will be reported to the parent's credit report as well as the student's.

Repayment and Forgiveness Options

Federal student loans are regulated by the government, so repayment options are the same no matter who your loan servicer is. The standard repayment term is 10 years, with a six-month grace period after graduation before your first loan payment is due. If your income is too low to pay off the loan in 10 years, you may qualify for income-based repayment programs. These can extend your repayment term to as long as 25 years, reducing your monthly payment in the process.

Private lenders don't have to follow the rules set for federal student loans, so your options for repayment and forgiveness will depend on the lender. For example, you might have to pay off a private student loan in five years, 15 years or some other time frame, or have to start making loan payments as soon as you graduate. You might even face a prepayment penalty for paying off your loan early, which is a contrast to federal student loans.

What if you lose your job or suffer some other financial hardship and can't afford your loan payments any longer? If your income drops below a certain level, you may be able to temporarily reduce or defer your federal student loan payments—in certain situations, the loan may even be forgiven. Private lenders may or may not offer this type of relief; you'll need to read the loan contract to see.

Loan interest payments are another factor to think about when comparing loan options. If you have a federal direct subsidized loan, you won't have to pay interest on the loan as long as you're enrolled in school at least half time. If you have an unsubsidized federal or private student loan, you'll be charged interest even when you're in school.

Interest Rates

Federal student loans have lower interest rates, and interest rates are fixed, meaning they won't change for the life of the loan. For loans first disbursed on or after July 1, 2019, and before July 1, 2020, the interest rate on direct subsidized and unsubsidized loans is 4.53% for undergraduates, 6.08% for graduate students and 7.08% for PLUS loans.

While federal student loans offer low, fixed interest rates, interest rates for private student loans are determined by each lender, and can be higher. In many cases, the rates are variable, which means they can rise or fall over the life of your loan. There may or may not be a cap on how high the interest rate can go. Variable-rate private student loans typically have slightly lower interest rates than fixed-rate ones. However, a rate increase can potentially add hundreds of dollars to your monthly payment, so be sure you're comfortable with that risk before choosing a variable-rate student loan.

Which Student Loan Is Right for Me?

Federal student loans should be your first choice when you're looking to borrow money for college. They offer approval with no credit check; low, fixed interest rates that are the same for every borrower; and plentiful options for repayment. Plus, if you qualify for a direct subsidized loan, you won't have to pay interest on the loan as long as you're attending school at least half time.

On the downside, student and Parent PLUS loans often have high interest rates. Because federal student loans set limits on how much you can borrow, you could borrow the maximum amount and still find yourself in need of money.

If you have exceptional credit and can qualify for a loan with a low interest rate and no origination fee, a private student loan could be the best option for you. (It could also be your only option if you've reached your federal loan limit and still need additional money.)

Whether a federal or private student loan is right for you depends on a variety of factors, including your income, how much money you need and your credit score. To find the best fit, take the time to carefully weigh your options—and be sure to read the fine print on any loan agreement before you commit to a student loan.

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