4 Key Differences Between Private & Federal Student Loans

When looking to pay for college, you generally have four options to help you cover the bills: scholarships, grants, private student loans and federal student loans. Scholarships and grants provide money you don’t have to worry about repaying, but the two loans come with expectations that you’ll repay them.

If you’re in the process of getting funding for your college education, and loans may be a part of it, it’s important to understand some of the differences between private and federal student loan programs.

1. Funding Sources Are Different

First up, the more obvious — the money you’re getting from these two types of loans are from different sources. Federal student loans are funded or subsidized by the federal government. Subsidies may come in the form of the government paying the interest on the loan while you are in school at least half-time. Private student loans are usually funded through schools, banks, credit unions or other types of lenders.

2. The Influence of Your Credit

Private student loans often require good credit or a cosigner. The interest rates of the loans and terms are credit-driven.

“With defaults on the rise, there was a major shift that lenders wanted ‘creditworthy’ borrowers,” Dr. Carrie Johnson, assistant professor of personal and family finance at North Dakota State University, said. “This means that now most college students will need to have a cosigner. Each lender makes this decision as to who they lend to, but for traditional students without income or a credit history, they will not be able to obtain a private student loan without a cosigner.”

(You can see where your credit currently stands by viewing two of your credit scores for free, updated every 14 days, on Credit.com.)

3. Interest Is Handled Differently

Federal loans have fixed interest rates, whereas private loans often carry variable rates. Interest rates for federal student loans are usually cheaper than private student loans. There is no legal limit to the interest rate that private lenders can charge you.

In addition, interest on federal loans can be tax-deductible, where private student loan interest is not tax-deductible. Another difference: With federal loans, the interest does not accrue while you are in school — private loans do not have this luxury.

4. More Repayment Options for Federal Loans

Federal loans offer many repayment options that take income and individual circumstances into account. These options include:

• Deferment – Federal loans usually allow a borrower to hold off on making payments until after graduation or until changing to part-time status. You may also be able to qualify for deferment post-graduation. Private student loans often require payments while in school, and while some lenders offer deferment or forbearance (see below) due to hardship, not all do and there may be fees associated with these options
• Forbearance – Payments are temporarily postponed for a period of time, but interest does accrue. Forbearance can occur in the case of illness, financial hardship, medical or dental internship or residency, or national service like Peace Corps, Americorps, or National Guard.
• Cancellation/Discharge – Part or all of the loan balance is forgiven.
• Income-Based Repayment – Federal student loans are eligible for the REPAY program.

Remember, the terms and conditions of private student loans will vary by lender. But, no matter what type of financing you’re looking into for college, it’s important to read the fine print thoroughly, ask questions about anything you don’t understand and crunch costs to fully assess your options.

Image: Boogich