There’s a consensus in the student loan world that students and their families should consider taking out federal loans before applying for private ones, and there are sound reasons behind that logic: Many federal student loans have benefits like a repayment grace period, the option of applying for income-based repayment and loan-forgiveness programs. Federal loans are easier to get for undergraduate students (they don’t require a credit check), and they tend to carry lower interest rates than private loans.
As beneficial as they are, federal student loans may not cover all a student’s education expenses, and depending on your financial situation, they may not even be the most affordable option.
Federal & Private Loans — What’s the Difference?
Your role in financing an education — student or parent — impacts the kind of loans you can get from the government. The Federal Direct Loan program is the most common kind of federal student loans, and there are a few loan types within the system. Here’s a quick description of those currently available:
Subsidized Stafford Loans: Undergraduate students who demonstrate financial need can qualify for these loans. There are limits to how much you can borrow, depending on how much you qualify to receive and your year in school. For example, a first-year, dependent undergraduate student can borrow only $5,500 in Stafford loans, and only $3,500 may be subsidized. Subsidized loans are appealing because the federal government pays the loan interest accrued before the student enters repayment, as long as the student meets the financial-need requirements.
Unsubsidized Stafford Loans: Undergraduate and graduate students can qualify for these fixed-rate loans, though there are annual limits to how much you can borrow, as determined by your year in school and other factors. The loans accrue interest from the moment they are disbursed, but you can pay the interest even before you enter loan repayment. For graduate students, Stafford loans are particularly appealing, because they carry lower interest rates than PLUS loans.
PLUS Loans: These loans are available to graduate or professional-school students, as well as parents of dependent undergraduate students. To take out one of these loans, you cannot have an adverse credit history (meaning your credit report must be free of unpaid collection accounts, foreclosure, bankruptcy, wage garnishment and loan default, among other things), but they often carry fixed interest rates lower than those offered by private lenders. Interest accrues on these loans from the moment they are disbursed, but unlike Stafford loans, there are no annual borrowing limits. Your school determines how much you qualify to borrow, based on education expenses.
Other federal loans include Perkins loan for students with what the Department of Education calls “exceptional financial need.” You can apply for Direct loan consolidation, as well. Direct loans include loan-origination fees, and Perkins loans do not.
One of the biggest differences between private and federal student loans is how a borrower qualifies: Undergraduates with no credit history can get federal loans in their own names, but the vast majority of undergraduates taking out private student loans require a co-signer, because 18-year-olds generally don’t have a sufficiently decent credit rating (or any credit history) to qualify on their own. Private student loans sometimes carry variable interest rates that start off lower than fixed federal loan rates, but over time, those rates may exceed the fixed rates, making private loans much more expensive in the long run.
Private education loans tend to have less flexibility than federal loans, as well. If you take out private loans, you need to be clear about any penalties or fees — some lenders charge you for paying your loan ahead of schedule — as well as the payment schedule you’re expected to meet: Many private loans require payments while you’re in school.
There are also benefits like consolidation, deferment, forbearance and student loan forgiveness to consider: You may not have any of these options with a private loan.
What’s the Benefit of a Private Student Loan?
Undergraduates should generally heed the advice of sticking to federal loans, but parents and graduate students may be able to find a better deal with private lenders. It depends on your specific situation, and you’ll want to carefully compare your options, but if you have a great credit history, you may want to go for private loans rather than a federal PLUS loan. Here’s why.
People with great credit scores may qualify for loan rates much lower than the 7.21% interest rate for PLUS loans disbursed between July 1, 2014 and June 30, 2015. Loan rates are expected to go up annually, as they’re tied to the 10-year Treasury note. The loan origination fee can add a hefty sum to your loan balance, because this year’s fee is 4.292% of the principal, and if you shop around, you might be able to find something less expensive.
On top of that, if you think you’ll be able to repay your loan quickly and you can do so without incurring fees, going for a private, variable-rate loan may keep your costs down. Of course, if you don’t pay the loan off quickly, that strategy can backfire.
Before deciding what student loan type is right for you, get a handle on your credit standing and research your financing options. To get an idea of where you stand, you can check two of your credit scores for free on Credit.com. No matter what you decide, make sure you’re prepared to consistently meet your debt obligations, because student loan delinquency or default can seriously damage your credit, which may make it more difficult for you to obtain credit in the future.
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