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Private vs Federal Student Loans: The Complete Guide

Private vs Federal Student Loans: The Complete Guide
Nancy Bilyeau
Nancy BilyeauUpdated August 6, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
When the possibility of college rises on the horizon, the question of loans does too. They go together without question. For several years, the number of American college students receiving financial aid has held at roughly 85%.As we all know, in the years following graduation, student loans linger. Sometimes the lingering becomes a crisis. Ten years is the ideal timeline for paying off student loan debt, according to financial experts and the U.S. Department of Education, says But in reality, it takes some borrowers closer to 20 years to pay off their student loans.Over time, your life changes; your finances change. A loan type that works at one point doesn’t work so well at another point. Understanding the differences between federal and private student loans can go a long way toward helping you navigate the smartest course for you.

What Is a Student Loan?

A loan is money that is borrowed and must be paid back with interest. A loan is not the same thing as a grant, which is a form of financial aid that doesn’t have to be repaid. Nor is it a scholarship. Many nonprofit and private organizations offer scholarships to help students pay for college, often based on academic merit, talent, or a particular area of study.Student loans can come from the federal government, from private sources such as a bank or financial institution, or from other organizations.

What Is a Private Student Loan?

A private student loan is made by a lender such as a bank, credit union, state agency, or a school—any entity that is not the federal government.Private loans have terms and conditions set by the lender. It’s important to read through the terms carefully.Since most students have limited credit history or little income, private student loans usually require a student loan cosigner. This is a parent or other family member who possesses credit and income and who agrees to take equal responsibility to repay the loan if the student borrower is unable.Some private lenders have specialized loans for things like medical or law school or they target groups like international students.

Pros of Private Student Loans

If you pursue a private loan while in college, there are no family income cutoffs in order to qualify. And the total amount of a private student loan is not limited—you can take out as much as you need to cover your costs.After you graduate, you may seek out private student loans through refinancing a federal loan to obtain lower interest rates and flexibility in setting the length of the loan. Private student loans offer fixed and variable interest rates. With private loans, variable rates often are lower than fixed and are a desirable option if you can pay off the loan before interest rates go up too much. In this way, people may lower their student loan payments.

Cons of Private Student Loans

The most significant drawback of a private student loan is you would not be eligible for any governmental student loan forgiveness. The pause in federal loan payments that began in March 2020 because of the pandemic is set to end in autumn 2023.The federal government may choose to forgive loan payments based on your job (such as sustained public-sector work) or if you have a disability. Also, you can pursue income-based payments should you suffer a job loss. These options are not available if you have opted for a private loan servicer.Private lenders tend to favor people with a strong credit history and a certain income to debt ratio. If you don’t possess these things, it may be more difficult to get a low monthly payment.Recommended: What Is a Master Promissory Note in Student Loans?

What Is a Federal Student Loan?

Federal student loans are made by the government, with terms and conditions that are set by law, and include certain benefits. They are intended to help people pay for college who wouldn’t otherwise be able to afford it.To obtain a federal loan, a student must fill out a Free Application for Federal Student Aid (FAFSA®) form. Based on the results, a college or career school will send a financial aid offer, which may include federal student loans. The U.S. Department of Education’s federal student loan program is the William D. Ford Federal Direct Loan (Direct Loan) Program. There are four types of Direct Loans available: 
  • Direct Subsidized Loans are loans made to eligible undergraduate students who demonstrate financial need to help cover costs.
  • Direct Unsubsidized Loans are loans made to eligible undergraduate, graduate, and professional students, but eligibility is not based on financial need.
  • Direct PLUS Loans are loans made to graduate or professional students and parents of dependent undergraduate students to help pay for education expenses not covered by other financial aid. 
  • Direct Consolidation Loans allow you to combine all of your eligible federal student loans into a single loan.

Pros of Federal Student Loans

One advantage of a federal student loan is that it offers future eligibility for forgiveness and other programs. Federal student loans also provide flexible repayment plans and options to postpone your loan payments if you’re having trouble making payments.For example, in 2021, according to the Department of Education, 30,000 borrowers received approximately $2 billion in student loan forgiveness under just one public service loan forgiveness program.There are other advantages too.You do not need a credit check or a student loan cosigner to get most federal loans.You don’t have to begin repaying your federal student loans until after you leave college or drop below half-time. If you demonstrate financial need, the government pays the interest on some loan types while you are in school and during some periods after school.

Cons of Federal Student Loans

There are limits to how much federal money you can borrow.If you are an undergraduate student, the maximum amount you can borrow each year in Direct Subsidized Loans and Direct Unsubsidized Loans ranges from $5,500 to $12,500 per year. If you are a graduate or professional student, you can borrow up to $20,500 each year in Direct Unsubsidized Loans.Some critics say that federal loans are far too easy to obtain and that college graduates struggle to repay their loans, causing long-term hardship. While 30% of undergraduates borrow money from the federal government, the total amount they borrow accounts for 92.6% of all student loan debt.Approximately 43 million Americans with federal student loan debt owe an average of $37,338 for their federal loans, says your federal loan go into delinquency and then default, the federal government has a number of options to get its money, including garnishing wages and taking you to court. Your credit rating may be ruined. Your school may withhold your academic transcript until your defaulted student loan is satisfied, meaning you can’t continue your education. Declaring bankruptcy rarely delivers you from student loan obligations.

Can You Discharge Student Loan Debt in Bankruptcy?

Discharging student loan debt in bankruptcy is historically not an easy lift. Federal lawmakers have set a higher bar for discharging student loan debt compared with other consumer debt, according to the U.S. Department of Justice. Student loan debts may be discharged in bankruptcy if you file for bankruptcy and can prove that student debt payments would impose an “undue hardship” upon you and your dependents. The Department of Justice in November 2022 announced a new process that can make it easier for debtors to discharge student debt in bankruptcy. The process allows debtors to complete an attestation form to help the Justice Department assess whether the debtor meets the undue hardship standard. Attorneys for the Justice Department would then review multiple factors before recommending whether a debtor should receive a complete or partial discharge of student loan debt.Recommended: Can You Declare Bankruptcy for Student Loans?

Differences Between Federal & Private Student Loans

Although both types of loans are used to pay for education, there are a lot of differences between those that come from the federal government and those that come from private lenders.This chart illustrates some of the differences:
Federal student loansPrivate student loans
When payments become duePayments aren’t due until after you graduate, leave school, or change your enrollment status to less than half-time.Many private student loans require payments while you are still in school, but some do allow you to defer (put off) payments while in school.
Interest ratesThe interest rate is fixed and is often lower than private loans — and much lower than some credit card interest rates.Private student loans can have variable or fixed interest rates, which may be higher or lower than the rates on federal loans depending on your circumstances.
SubsidiesIf you have financial need, you may qualify for a loan for which the government pays the interest while you’re in school on at least a half-time basis and during certain other periods. This type of loan is called a "subsidized loan.Private student loans are often not subsidized. In the case of an unsubsidized loan, you will be responsible for all the interest on your loan.

Choosing a Loan for College

When deciding which kind of loan to pursue for your education, consider not only your family resources but your planned career and your lifestyle goals. It’s important to consider the impact of years, if not decades, of debt.The Department of Education website alludes to expectations in this featured warning: “REMEMBER: Your federal student loans can’t be canceled or forgiven because you didn’t get the education or job you expected or you didn’t complete your education (unless you couldn’t complete your education because your school closed).”

Student Loan Refinancing Options With Lantern

After graduating and making payments on a federal loan for a number of years, some people may decide to switch to the private sector. A lender pays off your existing government loan and creates a new one. This is called student loan refinancingWith student loan refinancing, you may be able to adjust your interest rate and repayment terms. It’s possible to compare student loan refinance rates through Lantern to see if you could qualify for a lower rate and more favorable terms.

The Takeaway

When it comes to private vs. federal student loans, each has distinct advantages and disadvantages. When you’re applying for a federal loan to pay for college, your credit rating doesn’t matter and, later on, if you have financial problems, income-driven reductions can be made. Nonetheless, many people find themselves paying off their federal loans for decades. There are many pros and cons of refinancing student loans. Refinancing to a private loan may allow you to take advantage of low interest rates to generate a reduced payment, but doing so eliminates eligibility for government forgiveness and other programs.
Photo credit: iStock/PeopleImages

About the Author

Nancy Bilyeau

Nancy Bilyeau

Nancy Bilyeau writes about student loans, mortgages, car insurance, medical debt and many other finance topics for Lantern. A veteran of the magazine business, she has edited stories on personal finance for Good Housekeeping and DuJour magazines and has written articles for The Wall Street Journal, Readers' Digest, Parade, Town & Country and Lifetime/A&E, among others. She is a graduate of the University of Michigan.
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