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Student Loan 101: Are federal or private loans better?

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If you need to borrow money to pay for college, you're not alone. The College Board reported that 54% of bachelor's degree recipients from public and private nonprofit universities graduate with student loan debt.

The two main types of student loans are federal loans and private loans. Which type of student loan you use can impact your repayment options and overall cost.

Are federal or private loans better? The answer to that question depends on your program, finances, and eligibility for financial aid.

What are federal student loans?

Federal student loans are a type of student loan where the U.S. Department of Education acts as the lender. They make up the vast majority of outstanding loans. In fact, federal loans make up 92.78% of the $1.76 trillion national student loan debt.

Financial experts and organizations like the National Association of Financial Aid Administrators, the Consumer Financial Protection Bureau and The Institute for College Access & Success all stressed exhausting all federal financial aid — including federal student loans — before turning to private loans. Why? They usually have lower rates than private loans, and the government provides more borrower protections and repayment options than private lenders.

For students and their parents, there are four different types of student loans available from the federal government:

  • Direct Subsidized: These loans are for undergraduate students only. Students must have significant financial needs. The government waives the interest that accrues while the student is in school, during the loan grace period and any periods of deferment.

  • Direct Unsubsidized: Direct Unsubsidized can be used for undergraduate or graduate programs; loans used for graduate school will have higher rates. The student is responsible for all interest that accrues.

  • Grad PLUS: Graduate and professional students can use Grad PLUS Loans to borrow up to the total cost of attendance of their program.

  • Parent PLUS: Parents can borrow money to pay for their biological or adopted child's undergraduate education.

All federal loans have fixed interest rates, and all borrowers — regardless of credit or income — qualify for the same rate for that type of loan. The default repayment term for all federal student loans is 10 years.

What is a private student loan?

Private loans make up a small part — just 7% — of the overall student loan market. Whereas the federal government issues federal loans, private student loans can come from banks, credit unions and other financial institutions.

Although federal loans have fixed rates, private student loans can have fixed or variable rates. Variable-rate loans typically have lower initial rates than fixed-rate loans, but the rates can change over time. And repayment terms can range from five to 15 years.

Students can use private student loans to pay for undergraduate or graduate programs. However, private loans are credit-based, meaning lenders have strict borrower requirements, and not everyone will qualify for a loan.

Private loan eligibility

Although requirements vary by lender, private lenders generally require borrowers to have good to excellent credit — meaning a FICO credit score of 670 or better — and meet certain income requirements.

Since college students may not have good credit (or any credit history at all) and are unlikely to have a substantial source of income, most students will need a parent or relative to co-sign the loan with them. By co-signing the loan, the relative shares responsibility for the loan's repayment. If the primary borrower falls behind, the co-signer has to make payments in their place.

6 key differences between federal and private loans

When considering which types of student loans to use, consider these six essential differences:

1. Annual and lifetime borrowing limits

Annual and lifetime borrowing limits are very different between federal and private student loans, with private loans having higher maximums.

The federal government established caps on Direct Subsidized and Direct Unsubsidized student loans. Depending on your dependency status and the year of college you're entering, the annual maximum ranges from $3,500 to $12,500 for undergraduate students and up to $20,500 for graduate students.

An aggregate or lifetime maximum also applies. It ranges from $31,000 to $57,500 for undergraduate students, and $138,500 for graduate students (that number includes all federal student loans you used for undergraduate study too).

With private loans, lenders rarely have a fixed maximum; instead, they allow students and parents to borrow up to the total cost of attendance for their program. Because their lending maximums aren't as restrictive as federal loans, they are a useful option for borrowers that have reached the annual or lifetime borrowing limits and need additional cash to pay for school.

2. Credit and income criteria

Federal loans are typically easier to qualify for than federal loans. Federal student loans have no minimum income requirements, and Direct Subsidized and Direct Unsubsidized don't involve credit checks.

Applicants for federal PLUS Loans will undergo a credit check, but the credit inquiry is less intensive. Rather than looking for a specific FICO score or better, the government reviews your credit report to see if you have an adverse credit history, meaning recent major credit issues like foreclosure, vehicle repossession or collections.

Requirements for private loans are more strict. Borrowers usually need to have established credit histories and FICO scores of 670 or better and meet income minimums. If they don't meet the lender's requirements, the only way to qualify for a loan is to add a co-signer to their application.

3. Interest rates and type of interest

Federal loans always have fixed rates, and the rates for undergraduate loans tend to be low. They also have disbursement fees deducted from the loan when it is issued to you. These are the rates and fees for federal loans issued between July 1, 2023, and June 30, 2024:

Private loans can have fixed or variable interest rates, and they rarely have origination or disbursement fees. Rates vary by lender and whether the loan is used for undergraduate or graduate programs. As of July 2023, rates ranged from 4.44% to 18.00% for variable-rate loans, and fixed-rate loans ranged from 4.42% to 18.00%. Out of the 10 lenders we evaluated, none charged disbursement fees.

Important: Grad and Parent PLUS Loans have the highest interest rate ever since the Direct Loan program was launched. Borrowers with excellent credit may qualify for private graduate or parent loans with lower rates, but keep in mind that private loans lack some of the benefits and protections of federal loans.

4. In-school payment plans

Federal student loans tend to be more generous in terms of in-school repayment than private lenders. Students do not have to make payments while they're in school or during their grace periods, a period of six months after they graduate or leave college.

With private student loans, you may have to make payments while you're in college. Private lenders typically have several in-school repayment options. Depending on the lender, you may be able to choose from the following plans:

  • Immediate: As soon as the loan is disbursed, you begin making full principal and interest payments each month.

  • Interest-only: After the loan is issued, you make monthly payments to cover the accrued interest while you're in school. Once you graduate, the payments increase, so you also pay toward the principal.

  • Fixed: With a fixed payment plan, you pay a specific amount, such as $25 per month, while in college. Once you graduate, the payments increase to cover the principal and interest.

  • Deferred: If you opt for deferred repayment, you don't have to make any payments until after you graduate. Because interest accrues during your time in school, the deferred payment plan has the highest overall repayment cost.

5. Repayment and hardship options after graduation

Where federal student loans stand out is in borrower protection. Depending on your situation, you may qualify for the following options:

  • If you're ill or unemployed: If you become seriously ill or lose your job, you may be eligible for a federal deferment program. With these programs, you can postpone your payments for several months at a time.

  • If you return to school: If you decide to return to school to earn another degree, you can defer your federal student loan payments until after you graduate from the new program or leave school.

  • If your payment is too high: If you cannot afford the monthly payments under a standard 10-year repayment plan, you may be eligible for an income-driven repayment (IDR) plan. The payments are based on a percentage of your discretionary income, and some borrowers qualify for payments as low as $0.

6. Loan forgiveness eligibility

Federal student loans are often eligible for loan forgiveness programs. For example:

  • Public Service Loan Forgiveness: Borrowers may qualify for Public Service Loan Forgiveness (PSLF) and get up to 100% of their outstanding loans forgiven after meeting the program's eligibility requirements. They must work for an eligible non-profit organization or government office full-time for at least 10 years and make 120 qualifying monthly payments.

  • Teacher Loan Forgiveness: Teachers that teach high-need subjects in low-income schools or education service agencies for at least five years can qualify for up to $17,500 of loan forgiveness.

  • Income-Driven Repayment Discharge: If you sign up for an IDR plan and still have outstanding federal loans at the end of your loan term, the government will discharge the remainder.

Private student loans aren't eligible for federal loan forgiveness programs like PSLF or Teacher Loan Forgiveness. But they may qualify for state loan repayment programs based on your employment or for employer repayment assistance.

Are federal or private loans better?

Federal student loans are the better starting point for most borrowers, but private student loans can fulfill a need if you reach the annual or aggregate borrowing limits, or don't qualify for federal student loans. Taking out a private loan could allow you to complete your program and earn the degree you otherwise wouldn't be able to finance.