Knowing the differences between federal and private student loans before you sign the paperwork can help you successfully navigate repayment and may ultimately help protect your credit score. Federal student loans come with significant benefits, such as lower fixed-interest rates and income-contingent repayment options, that typically make them the smart choice when compared head-to-head against a private loan.
Basic Loan Origination and Interest
Students can qualify for federal student loans based on need, without a credit check or a cosigner. Private student loans offered by banks, credit unions, schools and other institutions typically make loans and set interest rates based on creditworthiness. Students without sufficient credit history or a poor credit history may need a cosigner to guarantee repayment of the loan.
Federal loan interest rates are usually lower than the rates charged by private lenders. For example, the interest rate for federal Direct Loans to undergraduates for the 2015-16 academic year was set at 4.29 percent, while the industry average for private student loans typically ranges from 9 to 12 percent. The federal interest rate is also fixed (meaning it doesn’t change throughout the life of the loan), while private loans may have a variable interest rate that can fluctuate over the life of the loan. As a result, payment amounts may not be consistent and can increase or decrease over the term of your loan.
Most private student loans set a specific date for you to start repaying the loan, which can often be while you’re still in school. Even if the repayment date is tied to your anticipated date of graduation, the loan likely makes no provision for changes to your academic plans. In comparison, students don’t have to start repaying federal loans until months after they graduate or change enrollment to less than part-time. Undergraduate students who go directly to graduate or professional school don’t have to worry about federal student loan repayments until they have completely finished their education.
One of the key differences between federal and private student loans is repayment flexibility. Private loans work like car loans: the terms are set, and the lender has no obligation over the life of the loan to take any of your personal difficulties into account. The federal government, on the other hand, has established a range of programs to help borrowers who have difficulty repaying student loans, including deferment and forbearance options that allow you to temporarily stop loan payments.
Deferment refers to the time during which repayment of the principal and interest of your loan is temporarily delayed. Forbearance, means you may be able to stop making payments entirely or reduce your monthly payment for up to 12 months. The government also offers repayment plans that tie monthly payments to your income level.
Loan Forgiveness and Discharge
A portion of your federal student loans can be eligible for forgiveness if you work in the public-service sector for more than ten years, and the loans may be eligible for discharge if you’re ever permanently disabled. A private student loan never goes away, regardless of your employment history or ability to work to repay the loan.