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Top 5 Differences – Federal and Private Student Loans

Today’s guest article is provided by Craig Anderson

It is the time of the year when students begin making student loans decisions. In many ways the decision is a simple one if the school offers a Federal Direct Stafford Loan, Graduate Direct PLUS Loan or Parent Direct PLUS Loan. But Private Student Loans are an additional option for students to consider. But what is a Private Student Loan and how does it differ from the Federal Direct Loans which have been the topic of so much media discussion in past months? Simply put, Private Education Loans are loans to the student which are directly from banks rather than the Department of Education.

Stressed Over MoneyBefore taking a look at the top 5 differences between Federal Direct and Private Student Loans it is helpful to first look at the similarities:

1)      All federal loans and nearly all private loans are certified by the school’s financial aid office. They will determine how much a student can borrow, typically cost of education less other aid.

2)      Most loan programs allow the student to defer payment of principal and interest while in school. The interest will still accrue (except on Subsidized Stafford Loans) and borrowing costs can be reduced significantly if the student makes some sort of in-school payment.

3)      They have to be paid back.

Top 5 Differences between Federal and Private Student Loans

1)  Interest Rates

Federal Loans

As of this writing, Direct Stafford Student Loans have a 6.8% rate. For a Subsidized loan the federal government will not charge you interest while the student is in school. This is a significant benefit for students. The Unsubsidized loan will accrue interest while the student is in school but payments can be deferred until after graduation. Another option is the Graduate or Parent PLUS loan. This rate is currently set at 7.9%. Interest accrues on these loans while the student is in school but payment can be deferred until after graduation.

Private Loans

Private loans are typically based on PRIME or LIBOR plus a percentage over that. The rate is based on the credit of the student and/or the cosigner. Depending on credit, students may qualify for a rate lower than federal loans offer. It could also be much higher. The rate is disclosed after the borrower completes the application and is approved.

Private Loans offer two different rate structures. The first is a variable rate. Variable rates can offer lower initial rates but can rise over time. As interest rates rise, so will the overall cost of the loan. Another alternative is a Fixed Rate private loan. The rate may not be as low as a variable rate loan, but it will never change.

2)  Fees

Federal Loans

In addition to the interest rate that will be charged on the loan, students will pay an origination fee. These are assessed upfront and taken out of loan proceeds. On a Federal Direct Stafford Loan the fee is 1.051%. On a Graduate or Parent PLUS loan the fee is 4.204%. On a typical Stafford Loan of $8230 the fee is around $86. The average PLUS loan of $12,186 will have an origination fee of $512.

Private Loans

The majority of private student loans do not charge origination fees; they have been eliminated along with back end repayment fees. The student will get exactly the amount borrowed from the lender.

3)  Cosigners

Federal Loans

The Federal Direct Stafford and PLUS Loans do not require a cosigner. In essence the federal government is the lender and cosigner. The only exception is if the PLUS loan applicant does not pass the credit criteria. In that case they will need an “Endorser” who effectively acts as a cosigner on the loan. They are agreeing to pay the loan if the borrower does not.

Private Loans

By law, private loan lenders cannot require the applicant to have a cosigner, but most students will want to have one. The typical undergraduate does not have a significant credit history so it is hard for lenders to determine the risk of making the loan. If the student is approved for the loan they will likely be charged the highest rate. Adding a qualified cosigner to the loan with good credit can lower interest rates, sometimes significantly. Many private loan lenders offer rates competitive with the federal loan programs, but only when a good cosigner is on the loan. It is important to recognize though the cosigner is now part of the loan transaction. They are agreeing to make the payments on the loan if the student borrower does not. Many cosigning parents don’t realize this and are surprised when they get that first call from the lender asking for payment.

4)  Repayment Options

Federal Loans

One benefit of the federal loan programs is the wide variety of repayment options they offer. Depending on what the student borrows, the payments can be large, especially right out of college. As a result, Congress has created a variety of repayment options that allow students to better manage their payments and align them with their income. This can be done by extending the repayment period of the loan or allowing the borrower to make payments as a percentage of their income instead of the standard principal and interest payment. While all these plans result in lower monthly payments, they can also result in the borrower paying significantly more than they would if they paid it off on the original terms. While these programs are helpful, borrowers should try to get back to making payments on the original terms as soon as possible. The Department of Education has considerable information on repayment plans including eligibility requirements and calculators.

Private Loans

Private Education Loans typically offer less repayment flexibility than federal loans. While most lenders offer students the option to defer payments until after graduation, they offer less flexibility once repayment begins. Regulatory requirements prohibit lenders from changing loan terms and conditions while the student is in repayment.  Lenders can offer temporary relief from loan payments in 2 month increments. But the lender can only offer this for a total of 12 months over the life of the loan and only if the student’s difficulty is temporary.

5)  Loan Discharge and Forgiveness

Federal Loans

In some cases federal loans can be forgiven or discharged. Under the Income Based Repayment (IBR) and Pay As You Earn (PAYE) programs borrowers’ loans can be forgiven after a number of years of payments. There are also additional options for students in Public Service positions as defined by the Department of Education. Loans may also be forgiven or discharged in the case of permanent and total disability, closure of the school the student is attending and some other circumstances.

Private Loans

Private loans vary on the circumstances under which a loan can be forgiven. Most forgive the loan in the case of the death of the borrower and some in the case of disability. Before accepting a private education loan it is a question borrowers should ask.

Conclusion

The real question then is when should a student borrow a private loan instead of a federal loan? That comes down to what the student (and their parent) wants to do. Federal loans offer many benefits, but with a good cosigner a student may be able to get a better priced loan. In some cases, parents don’t want an education loan in their name, but they are willing to cosign for a private loan.  Or, a student may need to borrow a private student loan because their federal loans are not covering the cost of their education. It is an important decision and one which every student should take some time to consider. Students may be told to borrow federal loans first as they are “always better.” It is not always the case; it depends on each individual student’s circumstances. Students and families considering private loans should take the time to do their research.

About the Author:

Today’s guest article comes from Craig P Anderson, who has been working in the Higher Education Finance Industry for over 20 years. He is a Student Loan Expert and has worked for a variety of student loan providers including Chase and Sallie Mae. He also worked in the Financial Aid Offices of the University of Florida and St. Petersburg College and has served on several industry boards. You can read more from him at CommonSenseStudentLoans.com or follow him on Twitter @CraigPAnderson .

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3 Responses to “Top 5 Differences – Federal and Private Student Loans”

  1. Great article! I’m getting my financial aid soon and all the names and amounts are confusing, this helped clear up some questions I had, Thanks for sharing!

  2. I’m glad it was helpful to you. Good luck!

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  1. […] Students and families considering private loans should take the time to do their research. See the full post at CheapScholar.org […]


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