Federal vs. Private Student Loans 

federal-vs-private-student-loans

Students seeking financial help beyond a grant or scholarship can seek two types of student loans: federal student loans and private student loans. The US government finances federal loans while private lenders provide private student loans. If you’re wondering which one to choose, this article will help you understand the differences between federal student loans vs. private student loans.

Private College Loans

Schools, credit unions, banks, and state agencies provide private student loans for financing higher education. The government does not back these loans, and the terms are set according to your circumstances. Private student loans are of two types: school channel and direct-student channel.

Usually, private student loans charge higher interest rates and have less repayment flexibility. So, why pay the extra premium? Students go to a private lender when they have maxed out their federal credit limits or missed the application deadline. Students who become ineligible for federal aid for failing to maintain Satisfactory Academic Progress (SAP) can also apply for private student loans. High-income students with good credit scores can get better interest rates and repayment terms by negotiating with the lender. Private student loans usually offer 6-12 months of no-payment grace period after leaving school.

Pros

  • Higher borrowing limit
  • Perks for deserving students with high creditworthiness

Cons

  • Higher interest rates, fees, and penalties
  • Non-flexible repayment terms

Federal Student Loans

The US Department of Education provides federal student loans to all US citizens studying for higher education. These loans are guaranteed by the DoE and require no credit checks. The US Congress decides the fixed interest rate of federal student loans each year. Federal student loans have favorable postponement options, income-driven repayment plans, and a lenient loan forgiveness policy. Federal student loans have a grace period of 6 months after you leave school. You can get a portion of your loan forgiven if you decide to work for public service. There are three types of federal student loans-

  1. Direct Unsubsidized loans – All undergraduate students are eligible. The school sets the credit limit.
  2. Direct Subsidized loans – Undergraduate students must demonstrate financial need to be eligible. Interest accrued while in school, deferment period, and grace period is paid by the government.
  3. Direct PLUS loans – Loans for eligible graduates/professional students or their parents to help fill expense gaps in cost of attendance (CoA).

Pros

  • Low-interest rate
  • Flexible repayment plans

Cons

  • Cap on borrowing limits
  • Non-bankruptable

Federal loans vs. private loans: comparison table

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Parameter Federal Student Loan  Private Student Loan
Loan Amounts Undergraduate students can get up to $57,500.

* Annual limit ranges from $5,500 to $12,500.

Graduate students can get up to $138,500.

* Annual limit is $20,500.

$1000-$50,000
Interest Rates Federal loans have fixed interest rates.

  • Direct Subsidized/Unsubsidized loans for Undergraduates – 3.73%
  • Graduate/Professional- 5.28%
  • Direct PLUS Graduate/Professional/Parent – 6.28%

Loan Origination Fee –

  • Direct loans – 1.057%
  • PLUS loans – 4.228%
Fixed APR: 3%-13%

Variable APR: 1%-12%

Subsidies Students who demonstrate financial need are provided with Direct Subsidized Loans.

Maximum Subsidy Limit:

  • Undergraduates – $23,000 subsidy on max credit of $31,000.
  • Graduates – $65,500 subsidy on max credit of $138,000, including federal loans for undergraduate studies.
No subsidies offered on private student loans.
Credit Check No credit check is required while availing federal student loan. Depends on the private lender.
Taxes Eligible for interest deduction up to $2,500 from taxable income. Eligible for interest deduction up to $2,500 from taxable income.
Postponement Options Federal loans have two postponement options:

  1. forbearance (interest accrued) or
  2. deferments (no interest charged).
Private lenders usually do not offer postponement options.
Repayment Plans A variety of repayment plans are available, ranging from 10-25 years. Repayment plans for private lenders vary between lenders.
Prepayment Penalties No prepayment penalties. Lenders are banned from charging prepayment penalties on education loans.
Where to Apply Students who wish to apply for a federal student loan can fill out the online FAFSA application form within the stipulated deadline. You can apply for a private school loan:

  1. From the lender’s online website.
  2. Some private lenders provide on-campus lending facilities.

Federal loans vs. private loans: in-depth comparison

Loan Amounts

Federal:

Loan Limits of each student depend on- 

  1. Dependency status 
  2. FAFSA info 
  3. Year in school 
  4. Other financial aid 

Undergraduate students – Aggregate maximum credit is $31000 (dependent students) and $57500 (independent students, including students whose parents are not covered under PLUS loans). 

Annual limit ranges from $5500 to $12500. 

Graduate students – Aggregate maximum credit of $138,500. This limit includes federal loans availed for undergraduate studies. Annual limit is $20500.

Private:

The minimum student loan amount is $1000 for all private lenders. 

The maximum amount ranges between $45000 and 500000, depending on the school-certified cost of attendance, financial aid, and any other expense you may incur while studying.

Interest Rates

Federal:

Federal loans have fixed interest rates. They use simple interest, so students don’t pay interest on interest

  • Direct Subsidized/Unsubsidized loans for Undergraduates – 3.73%
  • Graduate/Professional – 5.28%
  • Direct PLUS Graduate/Professional/Parent – 6.28%

Loan Origination Fee – PLUS student loans are at a disadvantage over this point. 

  • Direct loans – 1.057% 
  • PLUS loans -4.228%

Private:

Interest rates of private student loans depend on the following factors – 

  1. Fixed/Variable
  2. Loan Amount
  3. Income prospects
  4. FICO score
  5. Simple/Compounding 
  6. Repayment terms 
  7. Co-signer 

The fixed APR ranges between 3-13%, while variable APR ranges between 1-12%.

Subsidies

Federal:

Students who demonstrate financial need are provided with the Direct Subsidized Loans.

Subsidy is provided in the form of interest payment by the government – 

  1. while you are in school
  2.  During the grace period 
  3. During deferment or loan postponement period 

Maximum subsidy limit:

  • Undergraduates – $23000 subsidy on max credit of $31000.
  • Graduates – $65500 subsidy on max credit of $138000, including federal loans for undergraduate studies.

Private:

No subsidies offered on private student loans.

Credit Check

Federal:

No credit check is required while availing federal student loan.
However, you become ineligible for new federal student loans if there are pending defaults on your previous federal loan.

Private:

Depends on the private lender. 

1. FICO scores above 800- you will get the best interest rate and repayment terms. 

2. FICO scores between 700-750- typical range of approved borrowers

3. FICO scores between 650-670- Minimum range for availing private student loans. You may require a co-signer.

4. FICO score is below 670- Only high interest rates loans from select lenders

Taxes

Federal & private:

Eligible for student loan interest deduction up to $2500 from taxable income. You need to mention it in form 1040 while filing taxes. Students who pay more than $600 in interest may seek Form 1098-E from their school.

Postponement Options

Federal:

Students can seek temporary relief from loan payments in all federal loans. Federal loans have two types of postponement options: forbearance (interest accrued) or deferments (no interest charged).

Private:

Private lenders usually do not offer postponement options. Some lenders offer loans with postponement plans but have high APR.

Repayment Plans

Federal:

A variety of repayment plans are available, ranging from 10-25 years. 

Here are the repayment plans for federal student loans- 

  1. Standard Repayment Plan
  2. Graduated Repayment Plan
  3. Extended Repayment Plan
  4. Revised Pay As you Earn Repayment Plan (REPAYE)
  5. Pay As You Earn Repayment Plan (PAYE)
  6. Income Based Repayment Plan (IBR)
  7. Income Contingent Repayment Plan (ICR)
  8. Income Sensitive Repayment Plan (ISR)

Private:

Repayment plans for private lenders vary between lenders. You can select either of the following repayment terms – 

  1. Immediate Repayment Plan 
  2. Interest Only Repayment Plan 
  3. Partial Repayment Plan
  4. Partial Payments Repayment Plan 
  5. Graduated Repayment Plan 
  6. Deferred Repayment Plan

Prepayment Penalties

Federal:

No prepayment penalties.

Private:

Lenders are banned from charging prepayment penalties on education loans.

Where to Apply

Federal:

Students who wish to apply for a federal student loan can fill out the online FAFSA application form within the stipulated deadline. First make sure to contact your loan servicer.

Private:

You can apply for a private school loan from the lender’s online website. You can also apply through the school-channel as some private lenders provide on-campus lending facilities.

 

COVID 19 emergency relief measures

In addition to the above, the US Department of Education had allowed the following emergency relief measures on account of COVID 19 –

  • Suspension of loan payments
  • 0% interest rates
  • Recovery proceedings halted on defaulted student loans

As per the DoE directive on Apr 6, 2022, these measures will continue through Aug 2022.

Conclusion

Student loans are an important aspect of career progression. You can cover most of your educational expenses with a federal student loan. It offers a low fixed interest rate and ample repayment flexibility for smooth career transitions. If your education budget exceeds the federal loan limit, you may seek financing from private lenders. You can negotiate for the best interest rates and repayment terms if you have a strong credit score or a cosigner with good creditworthiness. It’s advisable to select the maximum repayment period for education loans to reduce the burden of future loan payments. You can always prepay student loans for free.

Matthew Levy Matthew Levy Last update:
Matthew is a freelance financial copywriter with 10+ years in financial services. He holds a Bachelor of Science degree in Economics with business and finance options and is a CFA Charterholder. He is from Vancouver, Canada, but writes from all over the world.