Federal vs Private Loans: 5 Key Differences
To pay for college, you can borrow federal loans, private loans or both. But what's the difference? Learn more about federal vs. private student loans here.
When it comes to paying for college, you can borrow federal student loans, private student loans or both. Each loan type of student loan has its own advantages and disadvantages, so it’s important to know what the differences are.
Here, we outline federal vs. private student loans so you have a clearer understanding of their major features before making a borrowing decision.
What Are Federal Student Loans?
Federal student loans are financial aid created and funded by the government through the U.S. Department of Education. You’ll need to fill out and submit the Free Application for Federal Student Aid, or FAFSA, to qualify. There are several kinds of federal student loans that may have their own eligibility requirements, but most offer flexible repayment plans. All interest rates are set by Congress each year and are the same for all borrowers.
Here are the main types of federal student loans:
- Direct Subsidized Loans: These loans are for undergraduate students who have demonstrated financial need. No credit check is required. While you're enrolled in school at least half-time and during grace or deferment periods, interest won't accrue — meaning the government subsidizes it.
- Direct Unsubsidized Loans: Meant for both undergraduate and graduate students, unsubsidized loans don't require that you prove financial need to qualify, but interest starts accruing when the loan is disbursed. You won't be required to make monthly payments, however, until you drop below half-time enrollment or your grace period ends. You can choose to pay the interest while you're in school or add it to your loan later on.
- Grad Direct PLUS Loans: These loans are for graduate and professional students and don't require the applicant to demonstrate financial need. Interest will accrue after loan disbursement, and applicants will need to go through a credit check to qualify.
- Parent Direct PLUS Loans: Meant for parents of dependent undergraduate students, Parent PLUS Loans aren't subsidized, and applicants need to go through a credit check to qualify.
What Are Private Student Loans?
Private student loans are originated and disbursed by private lenders, such as banks or credit unions. Unlike the federal government, private lenders set their own rates and may have higher borrowing limits. Plus, private student loan interest rates may be variable or fixed interest rates, and you may have access to different repayment terms depending on the lender and the type of loan.
You will need to fill out a separate application for each private lender you want to borrow from. You’ll also need to undergo a credit check and be able to meet the minimum income requirement to qualify. Many students utilize co-signers in order to qualify for a loan.
Federal vs Private Loans: What Are the Differences?
Although both federal and private student loans are intended for students or their parents to borrow money for educational purposes, there are notable differences to be aware of.
Federal loan interest rates are set by Congress each year and are based on the 10-year Treasury rate plus an additional increase. All the rates are fixed, except for some loans disbursed before July 2006. Every borrower will receive the same interest rate, though the rates do differ depending on the loan type.
Private loans, on the other hand, offer both fixed and variable interest rates. Applicants can opt for either option. Since private lenders set their own rates, rates differ depending on the lender. Other factors that may affect your rate include your credit score and income; the more creditworthy you are, the lower interest rates you’ll typically receive.
Private lenders have varying policies about charging application and origination fees. Federal student loans have origination fees, which may be lower than private lenders’ origination fees.
Federal loans tend to have less stringent requirements than private lenders. Applicants for Direct Subsidized Loans and Direct Unsubsidized Loans don’t have to go through a credit check to qualify, though Direct Subsidized Loans do require applicants to demonstrate financial need.
While PLUS Loans require a credit check, the purpose is to see if you have an adverse credit history, not to look at your score. Even if you do, you may be able to qualify for a loan if you can prove that your adverse credit history was due to reasons such as financial hardship.
When it comes to private loans, applicants will most likely need to go through a hard credit inquiry (your credit score may be affected), and you’ll need to provide proof of income. It may be harder to qualify for private loans if you have bad or limited credit history, and most students apply with a co-signer to increase their chances of qualifying for lower rates.
Both federal and private student loans have borrowing limits. Federal loans have limits on both the amount in loans you may be eligible to receive each academic year and the total amount you may borrow. The loan limits vary depending on what year you are in school and whether you are a dependent or independent student.
Private lenders may allow borrowers to take out more. That’s one of the main reasons students or their parents borrow from private lenders: to fill the funding gap after taking out federal loans.
If you decide to take out a private student loan, consider Juno. Juno negotiates on your behalf and guarantees you won’t find a better private student loan interest rate than the deal it brings you from its lending partner. Join Juno to learn more about your loan options for affordable private student loans to help fund your degree.
Federal loans offer unique repayment options such as income-driven repayment plans — usually based on a percentage of your income — as well as student loan forgiveness programs if you’re eligible for them. Federal loans also come with built-in borrower protections like deferment and forbearance.
Private lenders don’t have the same benefits. Some lenders offer a deferment or forbearance option if you face financial hardship, but it tends to be limited to a specific period.
Which One Is Better?
The truth is that neither one is better than the other, though each has advantages and disadvantages. If you’re looking for the lowest rate and can qualify, private loans may be a good choice.
However, most borrowers opt for federal loans first for several reasons, two of which are that they’re generally easier to qualify for and that they offer federal benefits such as income-driven repayment plans.
Whichever option you choose, it doesn’t hurt to fill out the FAFSA to see what you qualify for. Plus, many grants and scholarships require you to complete the form anyway. Who doesn’t love free money?
Sarah Li Cain
Sarah Li Cain is a finance writer and a candidate for the Accredited Financial Counselor designation whose work has appeared in places like Bankrate, Business Insider, Financial Planning Association, Investopedia, Kiplinger, and Redbook. She’s the host of Beyond The Dollar, where she and her guests have deep and honest conversations about money affects their well-being.
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