These days, it seems to be less about whether you’ll take on student debt and more about how you will take on student debt — and how you’ll get out from under it. The student debt crisis in the U.S. is a $1.5 trillion problem, and if you are now embarking on higher education or have a child who is, you may be feeling not only pressured, but confused about which type of loan to choose to minimize student loan debt: private loan or a federal loan?
It’s not necessarily a black-and-white situation. Each has its pros and cons.
“Depending on the school or institution the student is attending, federal and/or private loans could be beneficial,” said Mary Jo Terry, managing partner at Yrefy. “Federal loans have different repayment terms and options available than private loans. This needs to be determined on a case-by-case basis.”
Explore the fundamentals of how both work so you can make an informed decision.
Federal Loans
“The government typically sets fixed rates of interest for federal student loans,” said Carl Jensen, a personal finance expert and the founder of Compare Banks. “In comparison to private loans, interest rates are frequently lower.”
In addition, federal loans “provide many repayment alternatives, such as income-driven payment plans … based on your salary and the number of kids,” Jensen said. “These programs may offer cost savings and freedom.”
Jensen also noted that federal loans have predetermined limits. “These restrictions can aid in limiting borrowing and averting overspending.”
Private Loans
Private loans, on the other hand, can have either fixed or variable interest rates, and rates are often set according to your ability to repay the loans.
“A strong credit history could make you eligible for low-interest rates,” Jensen said. “Nevertheless, you might require another person to cosign if your credit is weak.”
In comparison to federal loans, private loans could provide fewer choices for repayment. “Private loans typically do not offer repayment plans or forgiveness programs that are income-driven. Private loans might provide additional possibilities for repayment, including the ability to select a payment period. Nevertheless, it’s crucial to take into account the whole cost of the loan’s repayment and how it may affect your future finances,” Jensen said.
Terry explained the pros and cons for both private and federal student loans.
Private Loan Pros
- Funding to attend non-Title IV schools and for international students
- Excellent credit rewards
- Higher borrowing limits
- Cover unexpected educational expenses and/or gap financing due to federal borrowing limits
- Quick application
- Both fixed and variable rate loans available
- Many lenders to choose from
Private Loan Cons
- Ineligible for federal loan programs and subsidies
- Variable rate, which may result in higher interest rates
- Cosigner may be required
- Debt not always dischargeable
- At risk for higher debt when entering repayment
Federal Loans Pros
- No credit check required
- No cosigner required
- Low interest rates
- No repayment required while in school
- In some cases, increased borrowing limits
- Multiple repayment options
- No prepayment penalties
- Federal program benefits
- Loan forgiveness
- Deferment programs while in school, on unemployment or disability, etc.
- Forbearance programs — up to two years of deferred payments
- Income driven repayment program sets monthly student loan payment at affordable amount based on income and family size
- Federal loan consolidation possible
Federal Loan Cons
- Take years to repay, may delay your financial goals
- Default has serious consequences, including loss of tax refunds
The choice between these two styles of loans is not apples to apples so much as it is apples to oranges. When possible, work with a financial advisor to help you choose what’s best for you and your future.
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