Do you need to pay for college and are wondering about your options? You’ve probably heard about federal and private student loans—but what are they exactly and how do they differ? Federal student loans are offered through the U.S. Department of Education, whereas private student loans are primarily offered by credit unions, banks, state agencies, or a school.
Which option will suit you best? It all depends on your credit history, the expected time you’ll take to pay off the debt, how much initial savings you have, and the total amount you need to borrow. Read on to learn more about federal student loans versus private student loans!
Federal Student Loans
Key Benefits & How to Apply
One key benefit of a federal student loan for undergraduates is that credit checks are not required. This is great news for the many undergraduates who have not had time to build a strong credit score.
To apply, students need to fill out and submit the FAFSA (Free Application for Federal Student Aid) which is available every October 1st. Depending on their financial situation, undergrads can obtain a subsidized loan – which means the interest is paid by the U.S. Department of Education while enrolled at least half time, during the 6 – month grace period, and during any period of deferment. Undergrads can also obtain an unsubsidized loan, but will be responsible for paying the interest during all periods.
Federal student loans offer a number of other benefits to borrowers, including longer periods of deferment and forbearance options for various circumstances, such as financial hardship. This means that if a borrower is in a short term financial bind, they may be able to temporarily suspend payments if eligible. As mentioned earlier, the government will cover the interest accrual for subsidized loans during any deferment period, but not unsubsidized loans. However, borrowers are typically responsible for the interest accrual on both subsidized and unsubsidized loans during any period of forbearance, except in the case of certain forbearances, such as the one offered as a result of the COVID-19 emergency. Borrowers can also take advantage of federal loan forgiveness programs and income driven repayment plans.
One main concern borrowers have is interest rates. Federal student loans have fixed rates, which is currently set at 4.99% for undergraduate students during the 2022-2023 academic year. For borrowers who expect to spend several years paying off their loans, a fixed interest rate can offer some peace of mind when it comes to budgeting.
Other Considerations
The biggest drawback for federal loans is that students pursuing their first college degree can only borrow a certain amount of money. The amount a student is eligible to borrow is determined based upon their year in school, and dependency status, and most often does not cover the full cost. Dependent undergrads – those who financially depend on their parents – can get up to $31,000, and independent undergraduates can get up to $57,500 over the full length of their program. The government will determine your dependency status based on information provided in the FAFSA. This maximum cap is not applied to federal PLUS loans for graduate students, or the parents of undergrads taking out a loan on their behalf.
Another point to keep in mind is that federal student loans, unlike private loans, require an origination fee, which is an initial amount that is discounted from the loan before it reaches your bank account. This fee is 1.057% for undergrad loans, and 4.228% for the federal Grad and Parent PLUS loans offered to graduate students and parents of undergrads.
Private Student Loans
Key Benefits & How to Apply
The process of taking out a private student loan starts by choosing a financial institution to apply with, and most lenders will review credit score and history. If your credit score is low or you haven’t built enough credit history, you may have difficulty taking out a private loan. However, applying with a credit-worthy co-signer will improve your chance of loan approval.
Students who do qualify for a private loan may be able to borrow the full amount they need, as private lenders’ often have higher loan limits, or allow you to borrow up to your cost of attendance, rather than using pre-established maximums. If your dream school costs more than what the federal government can offer you, this may be the way to go. It’s always smart to consider maximizing your federal loan options, and then borrowing a private loan to cover the gap between your financial aid and cost of attendance.
Interest rates for private loans vary widely, depending on the lender and your economic standing. However, borrowers with higher credit scores might find lower interest rates than the fixed rate offered by the government. Private lenders may also offer variable interest rates, which can be beneficial to borrowers who are prepared to pay their loan back quickly after graduation.
Another factor to consider is that private loans do not usually require origination fees, so you will have the possibility to save more money at the beginning.
Other Considerations
Undergrads with low or non-existent credit scores may have difficulty qualifying to borrow money from a private lender; or if they do qualify, may be offered higher interest rates. Applying for a private loan with a co-signer, such as a parent or guardian, is a good way to increase your chances of approval and a lower interest rate. In addition, private loans typically offer shorter deferment periods as compared to loans from the federal government, without the option to pause interest accrual—so be sure to ask your lending institution about their deferment and repayment policies. Some private lenders, like HUECU, do offer a 6 – month grace period for students once they graduate or fall below half time enrolment status, and additional forbearance and deferment time depending upon your plans to go back to school, or financial situation.
