Understanding the Key Differences Between Federal and Private Loans

Most students who are entering college today will need some form of financial aid in order to cover all of their college related financial expenses.
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Most students who are entering college today will need some form of financial aid in order to cover all of their college related financial expenses. For those who now have to apply for a student loan, there are a few choices that still need to be made. One of those choices is whether to take out a federal student loan or a private one. What are the key differences between the two? Let's take a look.

The Types of Federal Student Loans

A federal student loan is designed specifically for post-secondary education and controlled mostly by the Department of Education. There are currently two federal student loan programs available through the US Department of Education. The larger of these two is the William D Ford Federal Loan Program. Four types of federal student loans are available under this program. They are:

  1. Direct Subsidized - Loans for undergraduate students who are eligible and show that they have financial need for the loan to cover their college costs.
  2. Direct Unsubsidized - Loans for undergraduate, professional and graduate students who may or may not be in financial need.
  3. Direct PLUS- Loans which are for graduate or professional students as well as the parents of undergraduate students who are still dependent on their parents.
  4. Direct Consolidation - Loans which consolidate all of a student's federal loans into one payment.

The second federal student loan program is the Federal Perkins Loan Program. It is a loan in which the school is actually the lender. The graduate and undergraduate students who apply for this loan must show extensive financial need.

What is a Private Student Loan?

A private student loan is made to students by a private lending institution in order to pay for the student's college needs. Some students use a private student loan to cover costs that were not covered by their federal student loan options. With a private student loan, you can borrow up to the full cost of your education including books, housing, tuition, etc. A private student loan almost always requires a cosigner in order to take out the loan.

What's the difference during school?

As the cost for a college degree increases, private loans are becoming increasingly common in order to help finance an education. Some private lenders do allow for deferred interest payment while in school. With federal loans, depending on if the loan is subsidized or unsubsidized, interest may or may not accrue while in school, therefore, a deferred private loan will accrue interest just like an unsubsidized loan. Only subsidized loans are advantageous while in school or in deferment.

What's the difference during repayment?

Private student loans typically have less repayment assistance options compared to federal student loans. Some federal loans allow you to take part in income-based repayment plans as well as Pay As You Earn plans. These plans are helpful to those in lower income brackets, but may extend the total repayment of your loans by several years. Private lenders are adding more options to borrowers such as deferment and forbearance in order to compete with federal offerings.

Which have better interest rates?

Federal loan rates vary from year to year, as do rates of private loans. Typically federal loans have lower interest rates, but that is not always the case. The current interest rate on a Direct Subsidized loan is 4.66% where as a private loan is slightly higher, however, variable private loans can be below 3% making them an attractive option for borrowers.

Once you graduate and establish a work and credit history, you become a more attractive candidate to refinance and lower your interest rates. Federal loans are one-sized fits all, meaning you have the same interest rate as someone who has a lower credit score and less income. Private lenders are willing to buy out your existing federal and private loans from borrowers who have a strong profile and offer you a potentially lower rate as well as consolidate all of your loans at the same time.

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