What Is The Difference Between Federal and Private Student Loans?

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federal and private student loans

Every fall and spring, a college student needs to apply for loans to cover the remaining cost of college that financial aid and scholarships will not cover. There are a couple different loan options to choose from, but the primary decision will be choosing between federal and private student loans. Each type of loan will pay the college bill, but are differences between federal and private student loans?

All About Federal Loans

Federal student loans are administered by the Department of Education. They are the most popular option among college students and their parents because of the multiple offerings and extra protection. They usually have lower interest rates than private loans. Let’s break down the different features offered by federal loans.

Interest Rates

Most federal loans have a fixed interest rate. This means you pay the same interest rate for the entire life of the loan. If interest rates drop, the rate might also lower but it will never exceed the original amount. Most private loans are variable rate loans (the rate can go up or down), although private fixed-rate loans exist as well. Variable rate loans typically have lower interest rates. But, you run the risk of paying more interest in the long run if rates increase and exceed the fixed rates offered at the time of loan origination.

Subsidized and Unsubsidized Loans

Depending on your total calculated need on the FAFSA form, you might qualify for a subsidized federal loan. These loans mean that the federal government pays the interest accrued while you remain actively enrolled in school. You will begin paying interest once the loan enters repayment status.

If you do not qualify for a subsidized loan, all the interest accrued will capitalize and be rolled into the principal when the loan enters repayment status six months after graduation. You can pay the accrued interest before it capitalizes to avoid paying interest on interest. Over the course of four years of study, the capitalization amount can be several thousand dollars.

Repayment Based On Income

Another benefit of federal loans is that you have more flexibility in negotiating the repayment of your federal loans each month. Certain professions pay less than others. It can be a struggle for a recent graduate to make the regular monthly payments of a federal or private loan until they have a few years of experience under their belt.

If you meet the income-to-expense requirements, your payment plan will be restructured to where you will owe up to 10% of your discretionary income. The loans will still need to be repaid, but this option allows you to make reduced payments without penalty.

Loan Forgiveness

Graduates that find employment for a government or non-profit organization may qualify for loan forgiveness after 120 (10 years) qualifying payments. Further qualification for this option also requires being enrolled in an income-driven repayment plan (discussed above) or a 10-year repayment plan.

Projecting your future employment situation at graduation, let alone 10 years after graduation, can be somewhat difficult to predict for college students or high school seniors. However, it can be a nice option to have in your pocket in case you need it.

Other circumstances when federal loans can be forgiven can be when the borrower dies or becomes permanently disabled. Note that it is harder to have private student loans forgiven for any of the reasons mentioned in this section.

federal and private student loans

Private Student Loans

For one reason or another, sometimes students will also need to go with private student loans. Here are the advantages of a private loan compared to federal loans:

No Borrowing Limit

A drawback of federal student loan programs is that a college student or family can only borrow so much money per college semester. If they do not have the cash to pay the difference, they will need a private loan. To avoid the hassle of applying for multiple loans, it might be easier to borrow all the money from one lender if the interest rates are similar to each other.

Competitive Interest Rates & Repayment Plans

Private lenders offer fixed and variable interest rates. They are usually a little higher than what is offered by federal programs. But applicants with great credit scores can qualify for rates that are competitive with or lower than federal interest rates. To qualify for these lower rates, the student will most likely need a co-signer with an excellent score. But, it is possible to get low rates through a private program.

Also, private loans also offer differ loan repayment terms. Federal loans often start with a 10-year repayment plan with the option to extend repayment up to 25 years. With a private loan, your repayment term will vary by the lender but it could be 15 or 20 years from the origination date. Loans with shorter repayment periods will have lower interest rates, but will charge a higher monthly payment to meet the payment deadlines.

A Private Market Solution

As a matter of principle, some families do not want to accept student loans from the government for personal reasons. It’s not required to fill out the FAFSA (required to qualify for federal loans) or accept federal loans before applying for a private loan. These loans offer another option to pay for school.

Similarities Between Federal and Private Student Loans

Although the two differ in a few ways, there are many similarities between federal and private student loans. The federal loans have more “perks” for students. This is especially true if a college graduate will be struggling to make the monthly payment. But, private loans are not the “scary monster” that people sometimes refer to. Federal and private student loans share some certain similarities.

Prepayment Penalties

Nobody wants to pay on their student loans until their own children begin attending college. Neither private nor federal loans charge prepayment penalties if you pay off your student loans in full before a certain date. Check the fine print before signing for a loan just to make sure. By paying more than the monthly minimum, you will save thousands of dollars in interest.


With either type of loan, you can also consolidate or refinance your loans. A graduate with a combination of federal and private student loans will need to apply twice for refinancing (once for federal and once for private). Most lenders will not allow the applicant to refinance in the same loan because you lose the special privileges of federal loans when they are combined with private loans.

Interest Rate Discounts

To reduce your monthly interest charge, both federal and student loans types offer interest rate discounts if you meet certain criteria. This can include scheduling automatic payment withdrawals instead of manually having to send a check each month. You might also earn a discount if you go through loan counseling or maintain a good GPA.

One final similarity between both programs is that loan interest is tax-deductible. Each tax year, you can deduct up to $2,500 in paid student loan interest. This can help you receive a larger tax refund and is an indirect discount on your student loans.

federal and private student loans

Which Is Better Between Federal and Private Student Loans?

Each person has different financial and personal needs. As today’s college graduates are leaving with more student loan debt than ever before, it might make more sense to maximize the federal student loan offerings because of the repayment and loan forgiveness options.

Nobody can predict the future and these “safety nets” might come in handy. This doesn’t mean that a college student that solely takes out private loans is doomed to financial failure.

At the end of the day, each student and family need to do what makes the best sense financially. As it can take at least a decade to repay the loans, much interest can accrue. Choosing an option with the lowest principal and lowest interest rate is the best decision.

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