Federal Student Loans vs. Private Student Loans: Pros and Cons

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For many students, the first step in the financial aid process is to fill out the Free Application for Federal Student Aid, or FAFSA. The FAFSA will tell you if you’re eligible for federal student loans. Another option is to go to private lenders to borrow money for school. However, private student loans are very different from federal student loans, in terms of interest rates, repayment plans and qualification.

Here’s a look at the pros and cons of each type of loan to help you decide how to finance your education.

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Student Loan Definitions

Federal student loans are offered directly by the government. Private student loans are non-governmental and are offered by lenders such as banks, credit unions or individual schools.

Pros and Cons of Federal Student Loans

There are a few different types of federal student loans, but the main pros are the same:

  • Interest rates are fixed
  • Loans can be subsidized
  • Repayment plans are flexible

Cons of federal loans include:

  • Loan amounts are capped
  • Wages and tax refunds can be garnished if in default

Learn: How Do Federal Student Loans Work?

Pros and Cons of Private Student Loans

Private student loans do carry some advantages over federal loans, including:

  • No caps on loan limits
  • May be able to leverage existing relationship with bank

Cons of private student loans include:

  • Interest rates are often higher
  • Interest rates can be variable
  • Repayment options are not as generous as with federal loans
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Read: 10 Best Private Student Loans

Here’s a deeper look at the nuts and bolts of federal versus private student loans.

Student Loan Interest Rates

Student loan interest rates vary based on the type of loan and the current market interest rate environment. The exception is a Perkins loan, which is a federal loan made through individual schools to students with exceptional financial need. These loans carry a 5 percent interest rate.

Here are the rates for direct federal student loans disbursed between July 1, 2017, and July 1, 2018:

  • Direct subsidized loans, which are offered to undergraduates only: 4.45 percent
  • Direct unsubsidized loans, for undergraduates: 4.45 percent
  • Direct unsubsidized loans, for graduate or professional students: 6 percent
  • Direct PLUS loans, given to either parents or graduate or professional students: 7 percent

Private student loans are priced like other types of loans, based on the ability of the borrower to repay the loan. Lenders such as Discover offer variable rates from 4.99 percent to 12.99 percent or even higher.

Related: How to Get the Student Loan Interest Deduction

Student Loan Repayment Terms

The standard repayment term for government student loans is 10 years. However, there are ways to modify this term if need be. For example, a graduated repayment plan starts out with smaller payments that gradually increase, generally every two years, with the total balance still paid off after 10 years. An extended repayment plan might give you up to 25 years to make all your payments.

There are five other modified repayment plans available for federal student loans:

  • Revised Pay-As-You-Earn Repayment Plan (REPAYE)
  • Pay-As-You-Earn Repayment Plan (PAYE)
  • Income-Based Repayment Plan (IBR)
  • Income-Contingent Repayment Plan (ICR)
  • Income-Sensitive Repayment Plan
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Most of these programs tie your repayment amount to between 10 percent and 20 percent of your discretionary income. Other than the Income-Sensitive Repayment Plan, which requires full payment within 15 years, the repayment plans forgive any amounts you’re unable to pay after 20 or 25 years.

You can consolidate multiple loans into a single loan through the federal government via a direct consolidation loan. In some cases, you might be able to extend the term of your debt as well.

In some cases, you can get at least a part of your loan forgiven via the Public Service Loan Forgiveness program. If you can make your student loan payment for 10 years or more and work for a governmental or non-profit organization, the PSLF can wipe out your remaining debt.

If you have a private student loan, you don’t qualify for any of these federal repayment plans. However, private loans typically offer you three in-school options to pay back your loan:

  • Deferred repayment, in which you make no scheduled payments while still in school (or in the loan grace period)
  • Fixed repayment, in which you pay a set amount each month you are still in school
  • Interest repayment, where you pay interest only while still in school

Once you graduate, you begin making normal payments of principal and interest. Certain private lenders, such as Sallie Mae, offer additional options, including deferral, forbearance or a graduated repayment period if you’re having financial difficulty.

Learn More: 15 Ways to Pay Off Student Loans

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Student Loan Default Consequences

The consequences of student loan default are severe. The default will be reported to the credit bureaus, damaging your credit report and making it difficult or impossible to get future loans. Since you’re likely to want to rent an apartment, buy a house or finance a car loan after you graduate, defaulting on a student loan can affect the quality of your life after school.

Other consequences of federal student loan default include the following:

  • Your full balance becomes immediately due and payable
  • You lose eligibility for additional student aid
  • You can no longer choose a repayment plan, receive forbearance or deferment
  • Any federal payments, such as benefits or tax refunds, can be withheld to pay off your loan balance
  • Your wages will be garnished
  • You can be taken to court
  • Your school might withhold your student transcript

Defaulting on a private student loan carries the same consequences of failing to pay any type of traditional loan. Your default will be reported to the credit bureaus, and you might be taken to court.

Student Loan Qualification

Qualification for federal student aid carries the following general eligibility requirements:

  • Demonstration of financial need
  • U.S. citizenship, or eligible noncitizen
  • Valid Social Security number
  • Registration with the Selective Service, if male
  • Enrollment or acceptance of enrollment
  • For Direct Loan Program funds, at least half-time enrollment
  • Satisfactory academic progress
  • Signed certification statement that you are not in default of a federal loan, do not owe money on a federal grant and will use federal student aid only for educational purposes
  • Demonstration of the qualification to obtain a college or career school education
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Meeting these eligibility requirements doesn’t automatically get you a financial aid package, but it does qualify you to apply.

For private student loans, you’ll qualify just like you would for a private loan of any type. You’ll need a good credit score and the ability to pay back the loan. For many students, odds of getting a student loan improve with the use of a co-signer.

Learn: How to Refinance Your Student Loans

Student Loan Borrowing Limits

One of the main advantages of a private student loan is that you can borrow up to the amount of the cost of your education.

Federal student loans, on the other hand, have limits as to how much you can borrow. The numbers vary based on whether you are a dependent or an independent student:

For Dependent Students

  • First-year undergraduate loan limit: $5,500, of which no more than $3,500 may be in subsidized loans
  • Second-year undergraduate loan limit: $6,500, of which no more than $4,500 may be in subsidized loans
  • Third-year and beyond undergraduate loan limit: $7,500, of which no more than $5,500 may be in subsidized loans
  • Graduate or professional students annual loan limit: Not applicable, as all such students are considered independent students
  • Subsidized and unsubsidized aggregate loan limit: $31,000, of which no more than $23,000 may be in subsidized loans

For Independent Students

  • First-year undergraduate loan limit: $9,500, of which no more than $3,500 may be in subsidized loans
  • Second-year undergraduate loan limit: $10,500, of which no more than $4,500 may be in subsidized loans
  • Third-year and beyond undergraduate loan limit: $12,500, of which no more than $5,500 may be in subsidized loans
  • Graduate or professional students annual loan limit: $20,500 (unsubsidized only)
  • Subsidized and unsubsidized aggregate loan limit: $57,500, of which no more than $23,000 may be in subsidized loans
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The Bottom Line

Federal student loans offer flexible repayment terms and fixed interest rates that are typically lower than those offered by private student lenders. For many students, federal loans are therefore the better choice. However, if you need a higher loan amount, private loans might be the right option for you. The same is true if you have an existing banking relationship and can negotiate lower rates or better terms from your bank.

Click here to read about the what this person wish they knew before paying for college.

Up Next: See the Average Student Loan Debt in Every State


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