Federal Vs. Private Student Loans

Taking out any student loan is a big financial decision. If you’ve exhausted the amount of federal student loans you’re eligible for, you may be considering additional, private loans to bridge the gap. If you are, there are particular, different characteristics of federal and private student loans to consider.

With many student loans, you may not have to start making full payments until after graduation. As a result, you may not feel the full impact to your day-to-day finances immediately. However, it’s important to consider how student loans fit into your future budget. According to our latest Consumer Pulse survey, 26% of consumers with private student loans say they will be unable to pay them.

Before taking out student loans, you’ll want to fully understand the amount you’ll owe, the loan’s terms and the potential impact to your credit health.

Applying for federal vs. private student loans

To receive federal student loans, those granted by the U.S. Department of Education, you need to fill out the Free Application for Federal Student Aid (FAFSA). Even if you have no or limited credit history, most federal student loans don’t require a cosigner. Federal student loans have a maximum amount you can borrow each year based on the type of loan. They also offer certain benefits that may not be available for private student loans, such as forgiveness programs and flexible repayment plans. As a result, federal student loans tend to be prioritized as a funding choice.

Private loans, on the other hand, are granted by banks or other financial institutions. These are often used if federal student loans don’t cover the full cost of expected educational expenses. Lenders may require you to have an established credit history in order to apply for a private student loan on your own. The minimum credit score required to be approved for a private student loan will depend on your lender. To aid in approval and secure a lower interest rate, private student loans may require a cosigner. When someone cosigns on a loan, they become equally responsible for the loan payments. Private loans can have higher borrowing limits than federal loans. They may offer different types of payment plans, but they’re usually not eligible for loan forgiveness programs.

How student loans affect your credit score

Student loans can affect your credit score and play a part in helping you build a healthy credit history. For private loans, the lender usually pulls your credit reports to check your credit history. This will result in a hard inquiry on your credit report, which can temporarily lower your credit score. If you’re applying with a cosigner, they’ll pull their credit report as well.

Loan shopping is important. You’ll want to compare interest rates and terms to get the best deal. Does adding hard inquires to your credit report by filling out multiple applications give you pause? Subject to certain state laws, you can potentially limit the number of hard inquiries related to private student loans on your credit report by bunching your loan applications within a short time frame. Most federal student loans don’t require a credit report pull, so they don’t result in a hard inquiry. One exception is Direct PLUS loans, which do require a credit check.

When you take out student loans, your lender will report the loan’s payment history to the nationwide credit reporting agencies. Your payment history for your credit accounts is a major credit score factor. Because student loans, both federal and private, may offer unique repayment options, you want make sure you’re clear about when and how much you need to be paying.

Missing payments can have a significant, negative impact on your credit health. On the other hand, consistently making on-time payments will help you build a healthy credit history. This can be helpful if you don’t have much experience with credit. If you want help understanding your credit report, use TransUnion’s interactive credit report guide which breaks highlights the important aspects of each section.

Refinancing student loans

When you refinance, you’re essentially creating an entirely new loan to pay off the old one. The new loan application may add another hard inquiry in your credit report, but the resulting savings is important. Plus, if you continue to practice good credit habits, the drop in score should be temporary. Refinancing private student loans can be a smart plan if you’re able to secure a lower interest rate. This could lower your payments and ultimately save you money. You can also refinance multiple private student loans into one, which may make payments easier to keep track of.

You’ll want to be cautious if you’re considering refinancing federal student loans, especially if you’re thinking of using a private lender to do so. When you refinance federal student loans into a private loan, you may lose certain repayment plans, forgiveness options or other benefits granted by the federal government.

Create a spending plan

As you consider your funding options, remember this: You don’t want to borrow too much, but you also don’t want to have too little, since the resulting stress can impact your academics. Go through a couple of budgeting exercises to try to come up with your total expected semester expenses.

Even if you’re not paying your loans while attending school, private student loans and unsubsidized federal student loans tend to accrue interest during that time. This means what you owe may grow during your time at school if you’re not making those interest payments. Try to calculate how much you’ll need to get through each semester comfortably. Your school’s office of financial aid is a good resource to help you plan and manage your student loans while you’re attending school.

Like home and car buying, education is one of life’s biggest purchases. Fully understanding your student loan terms and payment schedules will help you manage and build repeatable habits for long-term credit health. To better understand how to track your student loans, head to our blog post about student loans on your credit report.