Many students require financial support through a third party to fund their education. The financial help might come from a scholarship, from you (thanks, Mom!) or student loans.
Confused between private vs federal student loans for college? Worried you’ll make mistakes as you try to choose the best option for your child?
That’s understandable — it’s important to consider various factors and choose the best combination of those types of aid. Both options work differently and have limitations, risks and benefits. They also have specific criteria which you need to fulfill before getting approved for the loan. Before borrowing, make sure you have a complete understanding of the chosen student loan option and its terms.
Guess what!! We’re here to put a spotlight on this matter and explain each of the student loans and the difference between these two loan types. Understanding the difference will help you choose the perfect student financing option for your kids.
Private loans offer a higher borrowing limit compared to federal student loans. Your child can get private student loans from different sources such as credit unions, private banks or other financial companies.
Your child likely doesn’t have a decent credit history so may need a cosigner to get a private student loan. If you, as the parent, are the cosigner, you must offer a credit check to prove your creditworthiness.
Kids may use a private student loan to pay for any expenses, including college tuition fees, room and board, textbooks, laptops or computers, transportation costs and living expenses.
Private student loans make up 7.87% of the total outstanding U.S. student loans, according to MeasureOne.Total outstanding private student loan debt: $131.81 billion.
Private student loans work more like secured loans such as a mortgage or car loan. Every lender’s different, but here are some steps you might go through to get one:
Step 1: Shop around.
Compare it all — interest rates, payment terms and fees — to find the most cost-effective loan that suits your needs. If you cosign when you borrow a private student loan, you’ll be responsible for making all the payments on behalf of your kids. It’s potentially risky, because if you can’t pay it back, your wages can be garnished to make the debt payments.
Step 2: Gather some information.
You’ll need information like your address, Social Security number, school information, academic enrollment period, requested loan amount, employment information and more.
Step 3: Fill out the application.
Your lender may review a few things with you after you fill it out.
Step 4: It’s in the lender’s hands.
They’ll review your credit, additional information and documentation. Some lenders offer instant approval of your application.
Step 5: Choose your interest rate and repayment options.
Involve your child in this process!
Step 6: Accept the loan terms.
Don’t forget to sign electronically.
Step 7: Your lender will get verification from the college your child plans to attend.
The school will certify your eligibility and enrollment and also verify the loan amount.
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Types of Private Student Loans
You can choose from three types of private loans.
Private Undergraduate Student Loans
You, the parent or cosigner, must submit credit and income proof for review. That way, the lender determines your ability to repay the loan. The lender also decides your interest rate.
Private Graduate Loans
Private graduate loans are for graduate students and have characteristics similar to other types of private student loans. Your graduate student might need you to cosign the loan due to a lack of sufficient credit. However, a graduate student with a decent credit history may also apply and qualify individually for a lower interest rate.
Private Parent Student Loans
Many private lenders offer parent loans directly to the parents who want to help a student pay for their education expenses. In this case, the student is not legally obligated to repay a parent loan.
Federal Student Loans
Federal student loans are governed and provided by the U.S. Department of Education. They have lower interest rates and flexible repayment plans for borrowers compared to private student loans.
Most student loans — about 92 percent, according to a June 2020 report by MeasureOne, an academic data firm — are owned by the U.S. Department of Education. Total federal student loan borrowers: 42.3 million. Total outstanding federal student loan debt: $1.54 trillion. Data courtesy studentaid.ed.gov
How Do Federal Student Loans Work?
A federal student loan is part of federal financial aid and is also called need-based financial aid. Confused? Check out What is need-based financial aid? for more information. Here’s how federal student loans work.
The FAFSA requires you to fill out information regarding your student’s financial status, especially about income and investments.
Step 2: Hurray! You’re done!
Once you submit the FAFSA, it’s sent to the schools your child’s interested in (you must choose them from a list on the FAFSA.
Step 3: Financial aid offices use something called your Expected Family Contribution (EFC) and cost of attendance (COA) to determine your final financial aid award.
The cost of attendance includes tuition, other required fees, room and board, textbooks and other expenses. The financial aid award may include several combinations of federal financial help such as federal Pell grants, federal loans and paid work-study jobs.
Step 4: Make some choices.
You and your child must review the details of each federal loan and accept which loans you’d like to utilize. For example, maybe you want to take a Direct Subsidized federal student loan but decide not to take a Direct Unsubsidized federal student loan (more on the differences between those two in a second).
Types of Federal Student Loans
You can categorize federal student loans into a few general types. Each of them has special characteristics, terms and qualification requirements. Let’s check them out.
Direct Subsidized Loans
Direct Subsidized loans are need-based, which means you must show need in order to qualify for them.
The federal government pays the interest on Direct Subsidized loans as long as your child is enrolled in school, for the first six months after he/she graduates and during any deferment or forbearance period.
Direct Unsubsidized Loans
Direct Unsubsidized loans are for undergraduate, graduate and professional students. Your child must pay the interest on unsubsidized loans, even while in school — the federal government does not pay the interest.
Pros and cons of Direct Unsubsidized and Direct Subsidized loans:
Pros
No credit check
A low, fixed rate of interest
Few flexible repayment plans
Prepaying the loan has no penalty
Cons
Lower loan limits
Students are required to file a new FAFSA form every year to maintain eligibility
The loan has stricter limits on usage, unlike private loans
Direct PLUS Loans
If you’re the parent of a dependent undergraduate student, you can tap into a Direct PLUS loan. PLUS loans are normally used to pay off the cost of education that other financial aid or loans do not cover. You’ll undergo a credit check to verify credit history.
The federal government caps the borrowing limit for Direct PLUS student loans. The loan amount limit may vary considering the type of loan, schooling year of your kids and whether the students are still dependent.
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Differences Between Private Student Loans and Federal Student Loans
It’s important to know the basic differences between private and federal loan types. Check some of the standout differences between private student loans and federal student loans.
Eligibility Criteria
Your child can qualify for federal student loans if he or she is a U.S. citizen or eligible noncitizen and if he or she is enrolled in an approved degree or certificate program.
Your student may require a cosigner to get private loans and may have to fulfill a lender’s credit and income requirements. Your student must also enroll in an approved degree or certificate program to get a private student loan.
Interest Rates
Federal student loans carry fixed interest rates. This means the interest rate is the same for the rest of your child’s loan term, no matter how much market interest rates increase or decrease.
Unlike a federal student loan, you can choose between a fixed or variable interest rate with a private student loan. Variable interest rates may increase or decrease based on market conditions.
Grace Period
Both federal and private student loans normally allow a grace period, which means no repayment is required until another six months after your student graduates. As a parent, it’s a good idea to read the fine print on the grace period before applying for a student loan.
Repayment Plans
Federal student loans may offer you multiple, flexible repayment plans, such as an income-driven repayment plan and extended repayment plan. These plans are offered to help borrowers if they face financial hardship to afford monthly student loan bills.
You might assume that private lenders only offer one student loan option with a set interest rate and repayment terms. But this is actually not the case. Several popular banks and private financing companies offer a variety of interest rates, as well as flexible repayment plans. However, private student loan companies are not required to offer flexibility and they do not offer loan forgiveness. Loan forgiveness can be an option with federal student loans to help you pay off your debts.
Forbearance and Deferment Options
Federal student loans offer forbearance and deferment options — but what do those actually mean?
Forbearance and deferment both mean that you can postpone student loan payments when you can’t afford them. The biggest difference between the two is that forbearance always increases the amount your child owes, while deferment can be interest-free for certain types of federal loans.
Most private lenders only offer deferment programs if you’re in the military or enrolled in school.
Deferment and forbearance are the same for private student loans — interest always accrues, and your child must pay the interest.
It’s a great idea to ask private student loan lenders whether they will let you pause payments if you or your son or daughter can’t afford to pay the loan payments for a while.
The Benefits of Private Student Loans and Federal Student Loans
Private and federal student loans both offer major benefits, and the main benefit is that they help your child go to college when you or your child can’t pay the gap between scholarships, grants and tuition, room, board and fees.
Benefits of Private Student Loans
A few quick benefits of private student loans:
They help cover the gaps in your child’s financial aid award and educational costs.
They aren’t need-based, unlike Direct Subsidized loans.
Most private lenders offer both fixed and variable interest rate options and loan terms for different borrowers.
Private student loan lenders allow your child to apply with a cosigner for a better interest rate and increase your chances for loan approval.
You may be able to release yourself as a cosigner from your child’s private loans.
Your child shouldn’t have to pay penalties if he or she pays off the student loan ahead of time in the vast majority of cases.
They offer competitive interest rates for borrowers or cosigners who have a great credit score.
You can tap into various repayment options, including deferred repayment, where you make no scheduled loan payments while you’re in school and during your separation or grace period.
Benefits of Federal Student Loans
Finally, check out some of the reasons you may want to opt for a federal student loan:
You don’t have to provide your credit history to get a federal student loan.
A fixed-rate federal student loan protects your child from increases in monthly payments if the market interest rate increases.
Federal student loans also allow your child to apply for forbearance or deferment. They offer more flexible repayment options.
Borrowers can consolidate multiple federal loans under the Department of Education’s Direct program through one payment per month, and an estimated 7.37 million federal student loan borrowers are on an income-driven repayment plan.
Repayment Plan
Payment Cap
Loan Balance Forgiveness
Current Number of Borrowers on Plan
Pay As You Earn (PAYE)
10 percent of discretionary income
After 20 years
1.31 million
Revised Pay As You Earn (REPAYE)
10 percent of discretionary income
After 20 years (25 years for loans taken out for graduate study)
2.56 million
Income-Based Repayment (IBR)
10 percent of discretionary income, or 15% if loan was taken out before July 1, 2014
After 20 years (25 years for loans taken out before July 1, 2014)
2.82 million
Income-Contingent Repayment (IBR)
Lesser of 20 percent of discretionary income or the payment on a 12-year fixed-payment plan
As a parent, you support and guide your kids, and guiding them through the student loan process is no exception. Consider your options and choose the best one according to your needs and financial status.
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