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Federal vs. Private Student Loans: 6 Key Differences Examined

Paying for college can be daunting. The average in-state student attending a public university can expect to spend $25,615 per year, according to Education Data.

You can reduce the cost with scholarships and possibly even grants. In many cases, however, this isn’t enough.

To make up the difference, many college students take out loans. And if you’re taking out student loans, you need to know what you’re getting into. In particular, you need to understand the differences between the two main types of student loans: federal and private.

Both types of loans can help you pay for college. But that’s just about where the similarities end.

In this article, we’re going to give you an in-depth comparison of federal and private student loans. We’ll look at the application process, interest rates, repayment options, and much more.

By the end, you’ll have the info you need to make an informed borrowing decision (and hopefully be convinced to avoid private student loans).

What Are Federal and Private Student Loans?

Before we get into the details, let’s take a general look at what private and federal student loans are.

Federal student loans are money the U.S. government lends you to help pay for higher education costs.

Private student loans are money that a bank or another financial institution lends you to help pay for higher education costs.

Typically, “higher education” refers to a 4-year undergraduate degree program. But you can also take out student loans for other accredited forms of higher education such as a trade school.

Aside from what they help you accomplish (paying for school), private and federal student loans have a variety of important differences. And that starts with the application process.

Federal vs. Private Student Loans: How to Apply

As with any type of loan, student loans require some paperwork. But the details of that paperwork vary greatly between private and federal student loans. Here’s a look at how each works:

How to Apply for Federal Student Loans

Your first step to getting federal student loans is to fill out the Free Application for Federal Student Aid (FAFSA). This form will provide your school with the info they need to determine your eligibility for student loans and other financial aid.

Once your school has reviewed your FAFSA, they’ll send you a financial aid offer. This letter will contain info on all the financial aid your college is offering, including any student loans.

Your school’s financial aid office will send you specific instructions on how to accept your student loans and other aid.

But in all cases, you’ll need to complete loan entrance counseling. This is essentially a short online course that ensures you understand how much you’re borrowing and how you’ll repay it.

Finally, you’ll need to sign a Master Promissory Note. This is a contract stating you agree to repay your loan (plus interest) to the U.S. Department of Education.

How to Apply for Private Student Loans

Unlike federal student loans, private student loans come directly from a financial institution such as a bank or credit union.

So the first step of the process is to compare lenders. Your school’s financial aid office may have a list of “preferred lenders,” and there are plenty of online comparison tools you can use as well.

Once you’ve found a lender that looks promising, you’ll need to complete a student loan application. Unlike federal student loans, your eligibility for private student loans is based on your credit score and financial history. So if you have a limited or adverse credit history, you’ll probably need a cosigner.

Assuming your loan application is approved, your lender and school will give you further information on how to apply the funds to your college costs.

Note: Please don’t take out private student loans. We included an overview of the application process to be thorough. But as you’ll see in the following sections, private student loans are just a bad idea.

Federal and Private Student Loans: Interest Rates Compared

Another key difference between federal and private student loans is the interest rate you’ll pay.

It’s easy to ignore the loan interest rate when you’re 17 or 18 and applying to college. But that number will have a huge effect on how quickly you can repay your loans after graduating. So be sure to pay attention.

Federal Student Loan Interest Rates

Federal student loan interest rates are standardized and fixed. The current rates are as follows:

  • Direct Subsidized and Unsubsidized Loans to undergraduates – 3.73%
  • Direct Unsubsidized Loans to graduate and professional students – 5.28%
  • Direct PLUS Loans – 6.28%

Confused by the different types of federal student loans? Check out this article for a detailed explanation.

The key thing to know is that all federal student loans have a fixed interest rate. Once you sign the paperwork and take out the loan, the interest rate on that document is the interest rate you’ll pay.

Private Student Loan Interest Rates

Private student loan interest rates aren’t standardized. The lender can set basically whatever rate they want, and that rate could be much higher than on federal student loans.

More importantly to know, many private student loans have variable interest rates. This means your interest rate can go up or down during the loan, drastically altering your monthly payment.

Not only is this confusing, but it also means you could end up paying much higher interest rates than on federal student loans.

For instance, a glance at Discover’s student loan page reveals variable interest rates between 1.29% and 10.59%. It’s easy to fixate on how low that 1.29% rate is, but that 10.59% is the number you should be worried about.

Are you starting to see why we don’t encourage you to take out private student loans?

How Much Can You Borrow?

If you’re an undergraduate applying for federal student loans, the maximum amount you can borrow each academic year is between $5,500 and $12,500. The precise amount depends on your year in school and whether or not your parents claim you as a dependent.

If you’re a graduate/professional student, you can borrow up to $20,500 in Direct Unsubsidized Loans each academic year. And you’re also eligible to borrow up to the full cost of attendance in a Direct Plus Loan (though we wouldn’t advise that).

Private student loans have no such restrictions. You can typically borrow up to the full cost of attending your school, provided the lender will give you that much. But please don’t do that — the higher interest rates and lack of protections make it a very bad idea.

Federal vs. Private Student Loan Protections

What do you do if you’re temporarily unable to make your student loan payments? Or what if your payments are too high to afford with your income?

If you have federal student loans, then you have options.

To start, you can apply for an income-driven repayment plan. The government will look at your income and then set a manageable monthly payment. It will take you longer to pay off your loan, of course, but it could give you the slack you need to afford essential expenses.

Next, federal student loans have options for deferment or forbearance. If you have life circumstances that temporarily prevent you from paying your loans, the government can pause your payments. You’ll have to fill out an application, and you need to meet one of the specific criteria. But it’s a great option to have.

With private student loans, it’s up to your lender to offer deferment or forbearance options. There isn’t a standardized program, and there’s no guarantee your lender will grant your request. This, along with the higher interest rates, is one of the most dangerous things about private student loans.

Federal vs. Private Student Loan Forgiveness and Discharge Options

Wouldn’t it be great if your student loans would just disappear? While that isn’t possible, you may have options for getting your federal student loans forgiven or discharged.

The federal government offers a variety of programs that can forgive or discharge all or part of your federal student loan debt. Here are your options:

The requirements for these programs are quite specific, and you’ll have to provide extensive documentation to get your loans forgiven or discharged. But at least you have the option.

With private student loans, there are no options for forgiveness. You may be able to discharge your loan as part of bankruptcy or in other specific cases. But doing so will likely destroy your credit score.

When Do You Have to Start Repaying?

A final key difference between federal and private student loans is when you have to repay them.

With federal student loans, you typically don’t have to start repaying until you:

  • Graduate
  • Drop below half time enrollment
  • Leave school

And even in these cases, you’ll have a six-month grace period before you have to start repaying any Direct Subsidized or Direct Unsubsidized student loans.

Graduate and professional students with PLUS loans also get a six-month deferment when they graduate, drop below half-time enrollment, or leave school.

Private student loans may or may not have a grace period. It’s up to the lender to decide. This means that in some cases, you might have to start making private student loan payments while you’re still in school. If that doesn’t sound like fun, then there’s another reason to avoid private student loans.

Think You Need Student Loans? Think Again

I hope this article has helped you understand the key differences between private and federal student loans. It may not be the most exciting topic, but making informed decisions about student loans now can save you years of frustration and financial hardship.

If you must take out student loans, stick with federal ones. The lack of protections and high interest rates make private student loans a dreadful idea.

And if you’re struggling to find the money you need to pay for college without private student loans, check out these guides for assistance:

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