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Federal student loans vs. private student loans

A student loan, is a student loan, is a student loan, right? In some aspects, that statement is true. For example, all student loans need to be repaid. After all, it is a loan and not a gift. The more you know today about eligibility, cost and repayment, the better off you will be long term.

Let’s look at the two main types of student loans, Federal Student Loans and Private Student Loans.  Each type has unique characteristics with different repayment terms and conditions, so knowing these differences can help you decide which loan program meets your needs. For the purposes of this article we will focus on student loans only—loans in the student’s name (the borrower)—and not parent loan options.

What is a federal student loan?

A federal student loan is offered by the Department of Education and is funded by the federal government. Once the loaned money is disbursed to your school, the loan is then managed by a non-government servicer throughout your repayment period.

What is a private student loan?

A private student loan is offered by a lending institution such as bank, a credit union, or school and can be funded and serviced by that lender.

Who is eligible?

  • Federal loans require you to be enrolled at least half time and be making satisfactory academic progress (SAP) order to be eligible for the loan. Private education loans may require either but rather require you to be enrolled in a degree-seeking, licensure or certification program at an approved college, university or other approved school.
  • Most federal student loans don’t require you to meet any credit criteria, although the PLUS loan for graduate and professional students requires you to not have adverse credit. Private loans are credit-based unsecured loans and typically have employment and minimum income requirements to ensure the borrower’s ability to repay the loan.  Many undergraduate students will not meet this requirement, and will likely need a cosigner.  A good cosigner is someone with a positive credit history that helps increase the likelihood of approval and also may help you get a better interest rate. Most private loan companies will offer a cosigner release option. This means that if specific requirements are met during repayment, the cosigner on your loan may be released.
  • Both federal and private student loans require the borrower to meet citizenship or residency requirements. Usually for private loans, it is required that you are either a U.S. citizen, U.S. national, permanent resident alien without conditions or international student who is a temporary resident alien with a U.S. address and proper documentation of eligibility.

What is the cost?

The cost of a loan is directly linked to the interest rate, fees and the loan term, so all of these factors should be considered when reviewing loan options.

  • Interest rate is what you will pay to borrow the money.  The interest rates for federal student loans are set by Congress.  All new federal student loans have a fixed interest rate.  You can find out more about these rates atstudentaid.ed.gov/types/loans/interest-rates#what-are-the-interest-rates-of-federal-student-loans.  The interest rate for private student loans is based on criteria determined by the lender. The most common criteria are creditworthiness and income.  Depending on the lender, the private student loan interest rate could be fixed or variable. Variable rates may change over the life of the loan, while fixed interest rates remain the same.
  • Capitalization happens when the interest that has been accruing while you were in school is added to the principal balance of your loan, increasing the loan amount. If you have a subsidized federal student loan, the federal government pays the interest while you are in school. If you have an unsubsidized federal student loan or a private student loan, you are responsible for paying all the interest that accrues. Many lenders will send you a statement periodically to tell you how much interest has accrued on your loan and let you pay it. This can help minimize the overall cost of your loan.
  • Fees are charges that you have to pay to originate or service your loan. These are charges you pay in addition to interest. Also keep in mind that the lender usually deducts fees from the original loan amount so the amount you receive will be less than the amount you actually borrow. However, you are still required to repay the entire amount you borrowed and not just the amount you received. The Department of Education charges fees for federal student loans. Before looking into a private student loan, research what kinds of fees, if any, the lender charges.  Some common fees are origination fees, application fees, late payment fees and non-sufficient fund fees.  Another important fee to investigate is a pre-payment fee (sometimes called a pre-payment penalty).  A pre-payment fee is actually a charge to pay off your loan early!
  • Term is the length of time you have to repay your loan.  Before you take out a loan, find out how long you have to pay it back.  Although having a long time to pay back a loan may seem good, keep in mind that interest continues to accrue on your loan throughout the entire repayment period, so a longer repayment term means that you may pay more in interest over the life of the loan than if you had a shorter repayment period.

How does repayment work?

Repayment is an equally important factor when considering a student loan and should be researched prior to taking a student loan.  When examining the repayment of a student loan, many people only look at the estimated payment schedule based on the first year of borrowing. To get a more realistic idea of what your monthly payment will look like, you should consider the total debt that you will incur to complete your degree. Also, take a serious look at your course of study and the job market for that field to be realistic about your earning potential.  Ask yourself if you will be able to comfortably repay that loan amount based on your career path.  You may be surprised. A great resource to help you determine the earning potential of a particular career is www.bls.gov/bls/blswage.htm.

What are some other factors that influence repayment?

  • Grace period. This is a period of time, typically 6-9 months, after you leave school or drop below the enrollment requirements when you don’t have to make payments. Not all student loans, including federal student loans, have a grace period. Be aware of when your grace period begins and ends to make sure you start making payments on time.
  • Loan servicer. The servicer will process your payments and be the company you call for questions about your loan(s) while in repayment.
  • Repayment term. The length of time that you take to pay back the loan (the term) can significantly affect the overall amount you pay on your loan.
  • Repayment options. Federal loans offer various repayment plans including standard repayment, graduated, extended, pay as you earn and even income based repayment. To select the option which meets your needs, visithttp://studentaid.ed.gov/repay-loans/understand/plans to review the options. Private lenders may offer more limited options. Work with your lender to understand repayment, as it can vary from lender to lender.  If your lender doesn’t charge a pre-payment penalty, then pay, pay away and get rid of that debt earlier and reduce your overall loan costs.
  • Deferment or forbearance. These are periods of time when you’re not required to make payments, for example, if you are having a financial hardship. For private loans, deferments and forbearances may be available but can vary by lender, so contact your lender for more details. Federal loans offer various options which can be found by visiting http://studentaid.ed.gov/repay-loans/deferment-forbearance. These options were designed to keep you from defaulting on your loan which carries a serious financial impact.
  • Loan forgiveness. The Federal government has several student loan forgiveness programs and should be considered when looking into a student loan.  You may visit these options at http://studentaid.ed.gov/repay-loans/forgiveness-cancellation. On private student loans, student loan forgiveness options vary by lender. Before you take out a private student loan, ask you lender what loan forgiveness options are available.

General loan tips:

  • Be involved. As the student, you are responsible for the repayment of your student loan.
  • Be aware. Research your loan options holistically. The factors above are not independent of one another; rather, they all work together. As an example, it is possible that you may receive a very low rate but have to pay a high origination fee.
  • Be savvy. Your student loans can be a great way to establish a positive credit history. Be sure to become educated on how credit works and how your choices can affect your credit long term.
  • Be proactive. Stay in contact with your lender or servicer, especially during hard times. If you are having trouble making payments, options are available to you which minimize the impact on your credit. If you don’t make payments and don’t contact your lender or servicer, they can’t help you.

Check with your school’s financial aid office for more information on what financing your school accepts. A little research now will make your finances a lot easier for you to manage in repayment.

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Dana Fulton
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Dana Fulton

Social Media Content Manager at Wells Fargo
Creative professional with years of sales and marketing experience, specializing in segment-specific strategy and customer-centric communications. Skills include problem solving, collaboration, critical thinking, and clarifying the complex.
Dana Fulton
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