There are some key differences to know and think about when it comes to federal and private student loans. Many of these differences affect how you obtain the loans and how you deal with them in the long run.
Let’s take a look at the 5 main differences:
1. Interest Rates
Federal Student Loans: Interest adds to the cost of your loan and is the deciding factor for many borrowers. Federal student loans typically beat private loans when it comes to interest rates. This is because when you take out a federal student loan, everyone is offered the same low, fixed rate that doesn’t change regardless of your credit score or income.
Private Student Loans: Private student loans are different as they give borrowers the option to choose between a fixed and variable interest rate. Variable rates will start off lower than fixed rates, especially during periods of low rates across the board, but they usually rise over time.
Fixed rates can be a safer bet since you know your rate won’t change or increase. But, if you have a steady income and plan to pay off your student loans quickly, a variable rate can be more beneficial as you can pay down the loan while the rates are low, avoiding those potential increases.
2. Application Process
Federal Student Loans: The application process for federal student aid, including loans, is completed online through the U.S. government by filling out the Free Application for Federal Student Aid (FAFSA). Students fill out this form in order to see how much they qualify for in federal loans. The process is usually pretty quick and painless and asks for basic personal and financial information.
Private Student Loans: Private loans differ since they’re offered through various financial institutions. It ultimately depends on the bank or lender you’re using, but generally, the process is the same. The lender will ask you to fill out an application with your information that they’ll review and then determine your lending options. Private lenders typically process these applications fairly quickly, as they know you need the money to pay for school.
3. Repayment Options
Federal Student Loans: Federal loans have a wide range of repayment plans to choose from, including graduated and extended repayment. Income-driven repayment (IDR) plan options are also available if your loan balance is too high for your income. With federal loans, there’s also a guaranteed 6-month grace period after you graduate or leave school before having to make monthly payments.
Direct PLUS loans are excluded from this scenario and have no grace period, except for graduate and professional students, who automatically get a 6-month deferment after graduating, leaving school, or dropping below half-time enrollment.
There’s also the potential opportunity for student loan forgiveness with federal student loans if you choose an IDR plan or if you qualify for loan cancellation programs such as Public Service Loan Forgiveness (PSLF) or Teacher Loan Forgiveness.
Private Student Loans: For private loans, on the other hand, repayment plans depend on the lender, but they may be more limited than federal loan options. Most lenders set you up on a repayment plan with fixed payments on a term of 10 to 30 years. You usually choose your repayment terms at the time you borrow and are expected to stick with them.
4. Loan Terms and Limits
Federal Student Loans: The loan terms for federal versus private loans can also look different. The standard loan term for federal loans is 10 years, whereas private lenders typically give you more time.
The borrowing limits are probably the biggest and most important difference when it comes to federal and private loans. For federal loans, a student can borrow Direct Subsidized and Unsubsidized loans between $5,500 and $12,500 per year.
Undergraduates can borrow up to $31,000 in subsidized and unsubsidized loans throughout their college career if they’re considered financially dependent on their parents or $57,500 total if they’re financially independent. This determination is based on the information from your FAFSA.
These borrowing limits can feel restrictive if you need more money to attend an expensive school. But, these maximums are put in place to help you keep your monthly debt payments affordable after you graduate.
Private Student Loans: For private loans, the borrowing limit varies from lender to lender, but generally, they’ll cover the cost of your education minus other financial aid, or up to 100% of the total cost of attendance. The general loan term for private loans is about 15 to 20 years. A longer-term might mean lower minimum monthly payments up front, but you might pay more over the life of the loan in the end.
Private loan lenders are in the business of lending out money to make a profit, so these institutions will typically lend you however much you need. This is only the case, of course, if you’re creditworthy, and be mindful of how much you take out since you’ll have to pay that money back one day.
5. Credit Requirements
Federal Student Loans: There’s no credit check for most federal student loans. Subsidized and unsubsidized federal loans are not based on your credit score, meaning any student can qualify. However, Direct PLUS loans for graduate students and parents do come with credit requirements, such as borrowers having no “adverse credit history.”
Private Student Loans: Private loans differ since lenders usually perform a much more in-depth credit check on all applicants. They can deny a borrower altogether or charge higher interest rates if the applicant’s credit score and income don’t meet their standards. Most private lenders require good to excellent credit to be approved for a loan. The majority of undergraduates are required to apply with a co-signer, since they typically can’t meet the credit and income requirements on their own.