College Planning: Federal v. Private Student Loans

March 8, 2023

Taking out a student loan to pay for college can be intimidating, confusing, and overwhelming. While “student loans” is often used as a catchall, there are considerable differences between federal student loans and private student loans—and even amongst the types of federal loans too. Simply put: student loans aren’t one-size-fits-all.

To help you make the best choice for your specific situation, we’re breaking down the important distinctions to keep in mind when deciding between federal and private student loans.

Federal Loans: Direct Subsidized and Unsubsidized Loans

These loans are taken out by the student and don’t require a credit check. Additionally, Congress sets the interest rate for Direct Loans at a fixed rate each year so it will not change over the lifetime of your loan.

Direct Loans come in two forms: subsidized and unsubsidized. For a Subsidized Loan, the Department of Education pays the interest while you attend school at least half-time and during the six-month grace period after you leave school. As a result, upon leaving school, the balance on these loans will equal the principal—the amount you initially borrowed. Once the grace period ends, interest will start to accrue. However, with Unsubsidized Loans, interest accrues as soon as the loan is disbursed.

Since you don’t have to worry about interest for a considerable amount of time with a Direct Subsidized Loan, this is the preferred loan type for many borrowers. The Direct Unsubsidized Loan doesn’t require students to demonstrate financial need in order to qualify. In both cases, your school—using information from the FAFSA—will determine how much you can borrow.

Federal Loans: Parent PLUS Loans

As the name indicates, parents or guardians take out this loan to pay for a dependent’s education. Borrowers need to complete a credit check to determine eligibility, and once approved, they’ll get a loan with a fixed interest rate. It’s worth noting that the interest rate on Parent PLUS loans is higher than that on Direct Loans. At the same time, the maximum amount one can borrow is higher than the Direct Loans maximum too: it’s the cost of attendance minus any other financial aid the student receives. 

Private Loans

This category has the most variety since loan terms are set by each lender. Private student loans may come from a bank, credit union, state agency or even a college. These lenders typically require established credit, which means many traditional students will not be eligible independently and may require a cosigner. In these cases, interest rates are generally determined by the creditworthiness of the applicant and can be either fixed or variable.

Loan Repayment

The type of loan you receive impacts when repayment begins, with federal loans offering the most flexibility. Students with Direct Loans aren’t expected to make payments while in school at least half-time. Once you leave school or drop below half-time status, you’ll have a six-month grace period before repayment begins.

With Parent PLUS Loans, this doesn’t happen automatically but borrowers can opt to delay repayment until the student leaves or enrolls less than half-time. Some private lenders may offer an option to delay repayment, but borrowers are typically required to make payments while in school.

Ultimately, the biggest benefit to federal student loans is the protections offered by the Department of Education. These protections include programs to lessen the financial burden of loan payments, including Income-Driven Repayment plans, and opportunities to pause payments, such as the CARES Act payment freeze, deferment, or forbearance. Federal loans also offer paths to forgiveness via President Biden’s Loan Forgiveness Program, Teacher Loan Forgiveness, or Public Service Loan Forgiveness. Different repayment options for private loans may be offered at the lender’s discretion but are likely less favorable.

When borrowing for college, it’s generally a good idea to start with Direct Student Loans due to their lower interest rates and more flexible repayment terms. If you do end up going the private route, take the time to compare different lenders and make sure you have a thorough understanding of your loan.

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