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5 major differences between federal and private student loans

Alyssa Pry
Personal Finance Reporter

If you’ve been to college or have recently graduated, chances are you have a student loan. About 43.3 million people have student loans, and 90% of borrowers take out a Federal student loan, according to the US Department of Education. But federal loans don’t always cover all of your college costs, and more borrowers are turning to private loans; according to a new study by LendEDU, 1.4 million people currently have a private loan to pay for college costs.

Experts recommend using Federal loans, financial aid, and scholarships before taking out a private student loan. Understanding the main differences between your loan options will help you determine the best way to fund your education.

Difference 1: How they’re funded

Federal loans are funded by the US Department of Education or private institutions that the government guarantee to pay back in case of default. Federal loans come with more protections, such as flexible payment schedules, lower interest rates and income-based pay-back programs.

Private loans are funded by banks and other lenders, such as credit unions, which means the lenders set the terms and interest rates. Interest rates are typically higher, and there is less flexibility for the borrower.

Difference #2: Interest Rates

The interest rate for federal loans is set by the Federal Reserve. They have fixed interest rates, which means the rate won’t change for the entirety of your loan. In 2017, the Federal Reserve raised the interest rate on undergraduate loans to 4.45%, and 6-7% for graduate student loans.

Private loans can have fixed or variable rates. Variable interest rates can fluctuate depending on the economy, potentially adding large amounts of interest to your loan. According to LendEDU, the average fixed-rate student loan is 9.66%, while the average variable rate is 7.81%, but rates can vary depending on your lender and loan terms.

Difference #3: Getting the loan

You will need to fill out the Free Application for Student Aid (FAFSA) in order to apply for a federal student loan, and you’ll also find out if you qualify for federal grants or other student aid. Your credit will not affect your ability to get a government loan.

There are three different types of federal student loans. A Direct Subsidized loan is given to students with financial need, and the loan interest will be paid by the federal government if you go to school part time, during the six months after you graduate or if you defer your loan payments. You can also receive a Direct Unsubsidized loan, which you are eligible for regardless of financial need, and you are responsible for all interest payments. Finally, you can receive a Direct PLUS loan, for graduate or professional school students.

Your ability to receive a private loan depends on your credit history, which will affect your loan terms and interest rates. You may also need a cosigner, such as a parent, who guarantees he or she will be responsible for your loan if you can’t pay it back. You don’t need to fill out the FAFSA in order to apply for a private loan.

Difference #4: Repaying the loan

You have a grace period of six months after you graduate before you have to start repaying your federal student loan. Most federal loan borrowers are put on a 10-year repayment plan, but you have up to 25 years to repay your federal loans in full.

Private loans may need to be repaid immediately—while you’re still enrolled in college—but you may have the option to defer payment until you graduate. There is less flexibility when it comes to your repayment schedule than with a federal loan, and the length you have to repay it varies depending on your lender.

Difference #5: Lowering your payments

If you’re having difficulty repaying your loan, Federal loans offer more options than private loans to lower your payments. You can defer your loan payments for up to three years, and your loans may be forgiven if you work in public service.

Private loans typically don’t offer loan forgiveness. However, if you’re having difficulty making your payments, you may be able to refinance the private loan. Refinancing means you consolidate your loan(s) into a new loan and repay the new loan at a lower interest rate. But, keep in mind, not all borrowers are eligible for refinancing.

It’s important to be a responsible borrower and know how much you’ll owe. And remember, the longer you take to repay your loans, the more interest will accrue.

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