Federal and private student loans may seem like two sides of the same debt coin. After all, whether you get your loans from a private lender or the federal government, you’re on the hook no matter what.
Well, it’s not that simple.
Deciding between a federal student loan or private student loan is not as easy as comparing apples to apples. It’s important for college students, graduates, and parents to understand exactly what makes a federal student loan a different animal from a private student loan. Their financial health might depend on knowing the differences.
Federal student loan definition
Federal student loans are issued and guaranteed by the Department of Education. Because the loans are issued by the government, interest rates for federal student loans are the same for every borrower, rather than being dependent upon the borrower’s credit rating or other financial factors.
You can apply for a federal loan by submitting a Free Application for Federal Student Aid (FAFSA) form. The Department of Education uses this to determine your expected family contribution toward your education.
Private student loan definition
A private student loan is any student loan that is not issued by the federal government. Unlike federal student loans, private loans are funded by banks, credit unions, and other types of lenders.
That also means that the interest rates for these loans are set by the lenders, based on the borrower’s credit history and/or other underwriting criteria determined by the lender.
Federal vs. private student loans
It’s important that you consider the following issues when deciding between federal and private student loans, or when considering whether to refinance your federal loans:
Student loan interest rates
In general, student loan interest is fixed on federal loans, which means the rate remains the same throughout the repayment period. Interest rates on federal student loans are currently tied to the 10-year Treasury Note, with an additional set percentage added on.
Private student loans, on the other hand, can offer fixed or variable rates. In the case of a variable-interest loan, your rate can fluctuate, changing your monthly repayment amount and increasing the amount you pay in interest over the life of the loan.
After borrowers have graduated and established a good work and credit history, they may find that private lenders are more interested in helping them to refinance their federal loans to a lower interest rate.
Again, refinancing from a fixed to variable loan could end up resulting in higher payments in the future. But depending on how high your credit score and income level is, you might find you can save money over your loan term by refinancing.
Private lenders do not offer the same kind of repayment options available with federal loans. In particular, borrowing from Uncle Sam means you are eligible for the following:
- You are not required to start repayment until after you have graduated. And if you have any subsidized federal student loans, you do not accrue interest while you are still in school or during the grace period after graduation.
- Federal student loans can be put on forbearance or deferment if you have an economic need for it. Some private lenders offer their own deferment/forbearance options, but they aren’t standard.
- You can limit the amount of your monthly payment based upon your income with a federal loan, as well as qualify for loan cancellation after 20-25 years.
- Borrowers who are pursuing careers in public service may be able to have their federal loans forgiven after 10 years.
- Federal loans are discharged upon the borrower’s death (or permanent disability, in some cases). There is no such discharge of private loans, and since many private loans require a co-signer, your co-signer will become responsible for your student debt after your death.
Consequences of default
Defaulting on your student loans is never a good idea, whether your loan originated federally or privately. However, borrowers do have a few more protections in place in case of default on a federal student loan:
- A private student loan is considered to be in default after 120 days of non-payment. Federal borrowers are not considered to be in default until 270 days of non-payment.
- A private lender will begin to seek payment from any co-signers on the loan when payment is simply late. They do not have to wait until the primary borrower is in default. Since federal student loans are not co-signed, borrowers do not have to worry about their student loan hurting their relationships.
- The lender may add collection charges to the amount the borrower owes, which can increase the loan balance by 25 to 40 percent.
- While the federal government can garnish your wages without getting a court order, the amount they can take is limited to 15 percent of your disposable income. Private lenders need to get a court judgment against the borrower in order to garnish wages, but depending on the state, they may take as much as 25 percent of the borrower’s income.
Choosing between federal student loans and private loans
In general, it’s a good idea to take out federal student loans in the first place and to keep them and their benefits post-graduation. However, if you have high interest rates and could benefit most from refinancing and saving money, a private loan might make more financial sense.
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