Federal and Private Student Loans: Pros and cons

Choosing between federal and private student loans isn’t always an easy call. They each have their own benefits and drawbacks. To decide which is the best for your personal circumstances, you need to know what your options really are.

How do federal loans work?

Federal student loans are financially insured by the federal government. Those issued over the last few years are also issued directly from the federal government. You can apply for federal student loans by filling out the FAFSA form each year you’re enrolled in college. Federal student loans are come in three versions: subsidized, unsubsidized, and PLUS loans.

You can learn more here but in short, subsidized loans don’t accrue interest as long as you’re enrolled at least half time. (That feature alone can save you several thousand dollars, since chances are you’ll be in school at least four years.) Unsubsidized loans do accrue interest but have other benefits such as not having an income limit. PLUS loans are designed for either graduate students or parents who still need help covering costs after they’ve maxed out the other options.

How do private loans work?

Private student loans are issued by private lenders and banks. They aren’t backed by the federal government and accrue interest as soon as you take out the loan. To obtain a private loan, the lender will want to check your credit report, income and may require a co-signer.

Pros and cons of each loan

Each type of loan has its own features, and therefore, a different set of benefits and drawbacks. Which loans are best for you will depend on what you need.

The key difference between federal student loans and private loans is this: federal loans can offer income-driven repayment options, the nonaccrual of interest while you’re in school, and guaranteed payment breaks. While some private student loan lenders also offer repayment plan options and breaks, you aren’t guaranteed to qualify for them.

Federal student loans are easier to qualify for and generally don’t involve credit checks. (PLUS loans do require a minimum, but easy to pass, credit check.) Private loans are harder to qualify for and your interest rate will depend in part on how good your credit is. Note: While federal loans often have lower interest rates, if you have excellent credit, you may get a lower rate from a private lender. And, because private loans aren’t need-based, you may qualify for a larger loan than you could through federal loans. 

Federal and private loans also have some differences in how they handle repayment. You can see the key differences below.

Interest rate & type (as pf 11/11/2020)

Federal Loans

• • 2.75% for undergraduate direct loans,
  • 5.30% for PLUS loans
  • Note: (All fixed rate)

Private Loans

• • Fixed rate: 3.82% to 14.50%
  • Variable rate: 1.20% to 12.99%
    
    

Credit check required

Federal Loans

• • No (except minimal check for PLUS loans)

Private Loans

• • Yes
    
    

Subsidized

Federal Loans

• • Often

Private Loans

• • No
    
    

Loan limits

Federal Loans

• • Undergrads up to $5,500 to $12,500 yearly, depending on if you’re a dependent and how many years you’ve been in school

Private Loans

• • Varies by lender, up to the total cost of attending college
    
    

Repayment terms

Federal Loans

• • Generally 10 years

Private Loans

• • Varies from 5 to 25 years
    
    

Loan forgiveness possible

Federal Loans

• • Yes

Private Loans

• • No
    
    

Repayment / deferment options

Federal Loans

• • Yes

Private Loans

• • No common
    
    

FAFSA required

Federal Loans

• • Yes

Private Loans

• • No
    
    

Cosigner needed

Federal Loans

• • No (except for PLUS loans if you have bad credit)

Private Loans

• • Normally not required, but it can help your application
    
    

Other considerations

There are some other details to consider when you’re weighing your loan options:

1. Interest options. If you can snag a private loan with a lower interest rate it isn’t automatically the cheaper deal, because it will accrue interest before your federal loan will. Break out the calculator to help you figure out which option will cost you less in the long run.
   
   Also consider the potential impact of a private loan with a variable rate. While they can start out much cheaper, if interest rates rise, so will your monthly payment. As this was published, interest rates are at near-record lows, they’re more likely to go up than down in the future. That doesn’t make variable rates a bad choice, but be sure you understand what you’re signing up for.
   
   
2. Origination fees. This fee, based on a percentage of the loan amount, is charged when you initially take out the loan. If you’re planning to pay back the loan quickly, this is a good option that will save you money.
   
   
3. Cosigning risks. Cosigning may or may not be required for private loans, but it always helps. But anyone planning to cosign a student loan should know their potential risks.

For starters, even if your student pays every penny on time, your credit score could take a hit because the debt is still considered yours and will change your debt-to-credit ratio. Worse, if the student you sign for can’t pay it — which happens more than you probably think — you are on the hook for the balance. Unlike other debt, student loans can’t be discharged in bankruptcy. If you also have trouble paying, you could find yourself fielding debt collection calls or having your paychecks getting garnished.

If you opt to cosign a loan for your child or another family member, make sure you have a lengthy discussion with the student to discuss what your expectations are and that they have a realistic plan for repaying the amount of the loan. (Psst. Our student loan repayment calculator can help.)

The type of loans you and your family choose is a personal decision you’ll have to make based on your finances and credit rating. Generally, everyone’s first choice are federal subsidized loans due to their perks. After that, you’ll to decide if unsubsidized federal or private loans make the best sense for your family’s circumstances. Be sure to review all of your options carefully. Check out this article for more information about comparing loans, and take a look at our comprehensive guide to filling out the FAFSA.