What you should know about private vs. federal student loans

There’s no question that higher education in the United States is expensive. According to ValuePenguin, the average total cost of college (including room and board, books and supplies, and transportation) is $25,290 for in-state public schools, $40,940 for out-of-state schools, and $50,900 for private schools. Considering those price tags, it’s no wonder there are currently 44 million student loan borrowers who owe an estimated $1.5 trillion, according to Forbes. For many people, it’s a given that they’ll take out student loans to pay for college.

The tough decision, though, comes when it’s time to figure out what kind of loans to take out: federal, which are issued by the U.S. government; or private, which are issued by banks, credit unions, and other lenders. Here are the primary differences to consider if you’re currently weighing those options.

The qualifications

The eligibility requirements vary between federal and private student loans. The government offers two primary types of loans — Direct Subsidized (on which the government pays some of the interest) and Direct Unsubsidized (on which the borrower pays the interest) — but only the former is need-based. “Some students or families may think that they won’t qualify for federal student loans,” said Erin Powers, director of marketing and communications with the National Association of Student Financial Aid Administrators. “But even if students don’t qualify for the Federal Direct Subsidized Loan...just by filling out the Free Application for Federal Student Aid (FAFSA), they will qualify for a Federal Direct Unsubsidized Loan.

Both of these loans require you to be enrolled at least half-time at an eligible college or university (if you’re not sure if your school qualifies, ask the admissions or financial aid office); while, Powers noted, with private loans, that’s not always the case. That said, according to NerdWallet, private loans come with more stringent eligibility requirements: Lenders will review your credit history, debt and other financial details to determine your likely ability to pay back the loan. Based on that information, the lender could turn you away or require a co-signer (such as a parent) with better credit.

The interest

All loans come with interest, but how much interest — and how much you’re responsible for paying — depends on the type of loan you get. “Federal student loans include various benefits that most private loans do not, like need-based subsidies that prevent interest from accruing while a student is enrolled [and] fixed interest rates,” Powers said. If you qualify for a federal Direct Subsidized Loan, the government will pay the interest while you’re enrolled (at least half-time), for the first six months after you leave school, and during a deferment (a period of time when you temporarily stop making payments or pay less each month). With a Direct Unsubsidized Loan or a private loan, though, you’re on the hook for paying the entire interest yourself.

As for how much that interest will be, the federal student loan interest rate is set by Congress, and is fixed for the life of your loan — meaning it won’t go up or down. The interest rates on private loans, on the other hand, are set by the lender and can be fixed or variable — the latter meaning the rate you pay can fluctuate over time based on the market.

Mark Kantrowitz, the publisher and vice president of research with Savingforcollege.com noted that federal interest rates are typically lower than private interest rates; though it is possible to get a low variable rate, depending on your credit and financial history. “But, even if a variable rate is lower than the fixed rate on a federal student loan,” he said, “it may be a more expensive loan” in the long-run if the rates rise.

While opting for a variable-rate private loan can be risky; according to Student Loan Hero, it may be a worthwhile move if you’re confident you can pay it off in a short repayment period (allowing less chances for a steep increase, and limiting the amount of interest that can accrue over time), you’re confident rates will remain low, or you want initial lower payments and the option to refinance later. With private loans, you have the option of refinancing with a different lender — and if you have a solid job and a strong credit history after college, you may be able to secure a lower interest rate.

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The repayment

“With federal loans, payments aren’t due until after you graduate, leave school, or fall below half-time [enrollment],” Powers said. “Many private student loans require payments while you are still in school.”

And once payments are required, federal loans tend to offer more options with more flexibility than private loans. “Federal student loans offer longer deferments/forbearances, death and disability discharges, income-driven repayment plans, and loan forgiveness,” Kantrowitz said. With income-driven plans, the amount you pay back each month can be adjusted based on your income, with the repayment period increasing to 20 or 25 years (from the standard 10 years). In some cases, such as if you work in public service or as a teacher in a low-income school, the government may also forgive a certain amount of your loans; in which case, you would be off the hook for paying that amount. That said, according to Forbes, the rejection rate for forgiveness applications is very high, so it’s important to not rely on this option — and if you do want to apply for forgiveness, pay close attention to the parameters and whether or not you’re within them. While some private lenders may offer some of theses benefits, Student Loan Hero noted such options are far less common.

And if you stop paying your loans for any reason; according to Student Loan Hero, private lenders can hit up your co-signers for money as soon as a payment is late, whereas the government must wait until you’re officially in default (270 days of not paying, compared to 120 days for private loans) to take action. Once you’re in default, the government can immediately resort to wage garnishment and other severe consequences; while private lenders must get a court order to do so. (Though, as Student Loan Hero noted, the federal government can only garnish 15 percent of your disposable income; private lenders can potentially take up to 25 percent).

Ultimately, both Powers and Kantrowitz recommended exhausting your federal loan options before taking out any private loans. But, the decision can be a complex one, so it’s always worth it to ask for help. “Financial aid administrators on your college campus are there to help walk you through the process of figuring out how to pay for college,” Powers said. “They can help you figure out what options are available to you, including how to take out loans, what types of loans you’re eligible for, what amount you may need to take out, and how to plan for repayment. Students who aren’t currently enrolled in college can call or make an appointment as a prospective student at any college or university to talk through the process with a financial aid administrator.”