Figuring out college-related finances before starting the school year can be a complicated and frustrating process. You’ll hear about federal loans, get ads for private loans, and wonder how to make the right decision about how much to borrow and where to borrow.
A good first step is to learn about the differences between federal and private student loans, including which option might be best for you as an undergraduate, graduate student, or even parent.
What are federal student loans?
Federal student loans are issued by the U.S. Department of Education and are available to eligible students attending a variety of schools, from four-year institutions to career-focused trade schools. According to MeasureOne’s Student Loan Report, federal loans will make up 92.11% of the $1.73 trillion in student loan debt in the United States in 2021.
The first step in the federal student loan process is to submit the Free Application for Federal Student Aid form. The data on the FAFSA — which includes your parents’ income and property information if you’re a dependent — will give the school the information it needs to determine the aid you can receive.
The most common federal student loans are direct subsidized and direct unsubsidized loans for undergraduates, also known as Stafford loans. Unlike loans from banks, credit unions or other lenders, subsidized or unsubsidized loans require no credit checks, and disbursement fees are low.
Direct subsidized loans help graduate students based on financial need, and the amount is determined by the school. These loans have the lowest interest rates, and the overall costs are low because the federal government covers the interest during and after college.
Direct unsubsidized loans are available to undergraduate and graduate students, even in amounts set by the school, with no requirement to demonstrate financial need. Interest on these loans accrues immediately, although you don’t have to start making payments until at least six months after you finish your studies. Compared to subsidized loans, unsubsidized loans also have higher interest rates.
The maximum amount you can borrow as an undergraduate for subsidized and unsubsidized loans depends on what year of school you’re in—as you progress through college, you’ll have the ability to borrow more each year—and whether or not you’re dependent. The maximum amount for these loans ranges from $5,500 to $12,500 per year.
Direct PLUS loans are loans that students can use to supplement their Stafford loans. These loans are for graduate or professional students (Grad Plus) or parents of dependent graduates (Parent Plus). The maximum PLUS loan amount you can receive is the cost of attendance—as determined by the school—minus any other financial aid received. Interest rates are higher than subsidized and unsubsidized loan options, they have higher disbursal fees and require a credit check.
What are private student loans?
Private student loans are issued to students and/or parents by banks, credit unions, and other lenders to cover college-related expenses. Loans can pay for anything from technical training to a bachelor’s degree to professional school. Some lenders have special loans for things like medical school or law school, or for target groups of borrowers like international students. They are much less common than federal loans, making up 7.89% of the total student loan market in 2021, according to a MeasureOne report.
Students who have maxed out their federal student loans may find that they still don’t have enough to cover the cost of college. There a private loan can fill the financial gap.
Private student loans offer fixed and variable interest rates. The lender will conduct a credit check, and because many college students do not have a good enough credit record to take out large loans, a parent is required to be a co-signer.
Private loans typically have a five- to 20-year term. Variable rates are often lower than fixed and are a good option if you can pay off the loan before interest rates rise too much, says financial aid expert Mark Kantrowitz. If you’re going to pay off the loan in full, a fixed rate is probably best, he says, as you can get a lower rate with a shorter repayment period.
The difference between federal and private student loans
There are many differences between private and federal student loans, including the amount you can borrow, the application process, and the forbearance and potential loan forgiveness.
Loan limits
The federal government limits the amount you can borrow with your Direct Loan, from a maximum of $5,500 for some undergraduates to $20,500 for graduate students in one academic year. There are also total limits — independent graduates can borrow as much as $57,500, while dependents can borrow no more than $31,000. Graduate and professional students can borrow up to $138,500, including all federal graduate loans.
PLUS loans have no cap; They are limited only by the cost of attendance determined by the school, minus any other financial aid you may be receiving.
Private student loan limits will vary by lender, but they are often more flexible than federal direct loans. Many lenders have no maximum, and those that do have higher caps such as $50,000 a year or $500,000 total. If you’ve maxed out your federal loan amount, private loans can be the bridge you need to pay for school.
Interest rates and accruals
Federal loan interest rates are set for all borrowers on July 1 of each year, are fixed rates for the life of the loan, and are often lower than private student loans. The graduation rate for 2021-22, for example, is 3.73%.
“It’s a really good deal,” says Kantrowitz. “There are private loans that offer fixed rates that are in the same ballpark as federal Stafford loans. But many borrowers will not qualify for those rates.”
Private student loan interest rates vary, often depending on how strong the applicant’s – and potentially a co-signer’s – credit history is. Rates can be variable or fixed, but are often higher than federal student loan rates and can reach double digits.
Interest accrues on most loans during college, whether federal or private, except for graduate-subsidized federal loans.
Approval process
Anyone applying for a federal loan must first fill out the FAFSA. Undergrads applying for federal student loans do not need a credit check to qualify, but those pursuing PLUS loans will have their credit history checked.
It’s possible to get approved for a private loan — you can apply online and get pre-approved in minutes thanks to automated credit underwriting, Kantrowitz says. “Generally, if you get this pre-approval, you’re going to get final approval.” A student will have to pass a credit check to get a private loan and will likely need a co-signer.
When co-signing, one person – usually a parent – takes on the loan as their own, which can affect their credit record until the loan is paid off. “A co-signer isn’t the same as giving a reference—you’re actually the borrower on that loan,” Kantrowitz says. “It’s your debt. It’s also the student’s debt.” In the most recent academic year, 90.57% were co-signers on private graduate loans, according to a MeasureOne report.
Payment plans
If you stay in college on at least a half-time schedule, you can defer repayment of your federal undergraduate and graduate student loans until you leave school. Students also have a grace period of six months after finishing college before they can begin repaying their loans.
There is no guaranteed graduate grace period for private loans – they vary depending on the lender. It’s common for lenders to offer four different payment plans:
- Deferred: Start paying principal and interest after you leave school. Payments can be delayed for up to nine months depending on the lender. Six months is normal.
- Interest only: Make interest payments while in school to reduce the overall cost of the loan.
- Partial: Make a fixed monthly payment while you are in school. Lenders usually set it at $25.
- Immediately: Start paying off principal and interest immediately. It has the highest school cost but is the lowest overall cost option.
Difficulty and support
If you’ve had trouble finding a job, become disabled, don’t earn enough to repay your debt in full, or are affected by a major economic event like the coronavirus pandemic, chances are good that you can get help — whether it’s deferred payment or another form of relief. – Through federal student loans.
“The choices for relief between the two products are very stark. That’s why I often recommend federal over private,” says Betsy Mayotte, president and founder of The Institute of Student Loan Advisors. For example, federal loan programs allow:
- Postponement: The federal government established a forbearance for all federal student loan borrowers due to the pandemic, allowing them to stop payments from March 2020 until at least September 2021. Borrowers can stop making payments, and interest stops accruing. In non-pandemic situations, you can enter into a deferment or forbearance agreement with approval from your loan servicer, although interest will accrue during the period your payments are delayed.
- Income-driven repayment plans: If deferment or forbearance isn’t enough, you can sign up for one of four income-driven repayment plans, which can limit payments to 10% to 20% of your discretionary income.
- Pardon or discharge: Federal loan programs can offer loan forgiveness through the Teacher Loan Forgiveness Program or, if you work in a non-profit or government organization, through the Public Service Loan Forgiveness Program. Also, loans can be discharged for many reasons, including disability or closed school.
Private lenders may offer some of these programs, but they are not guaranteed. “But for the most part, there are very few opportunities for relief for those borrowers,” Mayotte says.
Some private lenders have offered coronavirus relief, for example, but borrowers are required to apply for loan forbearance and it’s only available on a short-term, month-to-month basis. In all cases, interest still continues to accrue.
How to choose between federal and private student loans
If you’re trying to decide which loan type — federal, private or a combination of both — is best for you, it might be best to start with the cost of each, both in the short term and over the life of the loan. Federal loans are “generally going to be cheaper and more available,” says Kantrowitz.
While it may take some time to estimate how much you’ll borrow over the course of four or five years, it’s important to figure out how much you can handle for loan repayments after graduation before you take out your first loan, Mayotte says.
Follow these pointers from Mayotte when you borrow: “Don’t borrow as forgiveness, don’t borrow more than you can afford, and make some assumptions based on your expected first year of borrowing instead of getting caught. Guard” after graduation, she says.