If you’re wondering why experts urge students to choose federal student loans over private ones? Wonder no more. It’s because there are many differences between federal student loans and private student loans, according to Federal Student Aid. These differences benefit student borrowers, making loans from the U.S. Department of Education preferable to those issued by private lenders.
No Credit Check Necessary
The process of getting a student loan from the federal government is easier than the process of getting funding from a private lender. Students have to fill out the Free Application for Federal Student Aid (FAFSA). This form can be submitted online or by mail and takes an average of just 25 minutes, Federal Student Aid reported. The same form can also help students qualify for federal grants (need-based funding they don’t have to pay back) and work-study funding as well as intuitional scholarships.
What’s missing from the application process for a federal student loan is the credit check requirement. The banks and credit unions that offer private student loans will consider your credit history when determining whether to loan you money for college and how much interest to charge. Since many students haven’t yet had the chance to build a strong credit history – or establish credit at all – this requirement can pose a serious problem.
Fortunately, credit checks are not required to get Direct Subsidized Loans, Direct Unsubsidized Loans or Federal Perkins Loans. Only graduate students or parents seeking federal funding on behalf of a child will ever have to undergo a credit check. Once you graduate, making your student loan payments on time can actually help you build good credit.
No Cosigner Needed
What happens when student borrowers don’t have great credit, or for that matter, any credit? A private lender will often require you to get a cosigner. This is an adult who has established credit and, ideally, a good credit score.
As a condition of approving your loan application, the private bank or credit union has the right to hold your cosigner financially responsible if you default on your student loan. While no one takes on college debt with the intention of defaulting on their loans, the consequences of a default can be severe enough to make many people – even your own parents – think twice about cosigning.
When you take out federal student loans rather than private student loans, you avoid this problem. In “most cases,” the government won’t ask you to have a cosigner for your loan, Federal Student Aid reported.
Fixed Interest Rates
No matter where you get your student loans from, you’ll have to pay interest on the money you borrow. However, the terms of one loan can differ sharply from the terms of another loan, especially when it comes to interest rates. Federal student loans always come with a fixed interest rate. This means the rate of interest you agree to will never change – and more importantly, it will never increase, costing you more money. Private lenders may not offer you this same security. Instead, private loans often come with variable interest rates, which can change throughout the course of your loan repayment. A variable interest rate may start off low, but can jump substantially and remain high.
Lower Interest Rates
In addition to being fixed, the interest rates on federal student loans are often lower than those on private student loans. For example, interest rates for the 2016-2017 school year were 3.76 percent for Direct Loans for undergraduates (subsidized and unsubsidized), Federal Student Aid reported. Interest rates were 5.31 percent for Direct Loans for graduate students and 6.31 for the PLUS loans often taken out by parents.
Private student loans, on the other hand, can have far higher interest rates – especially when those rates are variable. The interest rates on student loans offered by private lenders can rise to 18 percent or more, according to Federal Student Aid – adding significantly to your debt.
Some – though not all – federal student loans are subsidized. This means that, during the time you attend school as a full-time student, you’re not accruing interest on your loans. Instead, the federal government pays that interest for you. This benefit even extends to the grace period after you leave school and, if you need to defer your payments to a later time, the duration of your loan deferment.
Subsidized loans still accrue interest during the time you take to repay your loan, but cutting out interest costs during these crucial points could add up to thousands of dollars of savings, depending on how much you borrow and how long you attend school full-time. Of course, the government doesn’t subsidize the interest on private student loans.
Repayment Doesn’t Start Until After You Leave School
When you take out student loans through the U.S. Department of Education, you’re not expected to begin repaying those loans at all during the time that you are a full-time student. That’s beneficial for a number of reasons.
When you’re focusing primarily on your studies, you probably aren’t working enough to bring in the kind of money needed to start paying down your college debt. If you do work, it’s probably part-time. You may be working as an intern to gain professional experience in your field, but that work may be for low pay or no pay. Since you don’t yet have your degree, you probably don’t have the kind of well-paid job that would help you afford student loan debt repayment in addition to your living expenses.
It makes a lot of sense not to require students to start paying back their loans while they’re still in school. Unfortunately, borrowers who take on private student loans don’t have this same protection. Many private lenders start requiring payments before students graduate, Federal Student Aid reported.
A grace period is a period of time before you have to make payments on your debt. When it comes to student loans, the federal government often allows students a grace period of six months between the time they graduate or leave school and the date your first loan payment is due. Interest may or may not accrue during this time, depending on the type of federal loan you received.
Not all federal student loans offer a grace period, so it’s important to understand the terms of your loans. PLUS Loans do not offer a grace period, and Federal Perkins Loans vary from school to school. However, most federal student loans, including Direct Subsidized, Unsubsidized and Stafford loans, do allow this six-month period for borrowers to choose a repayment plan, get financially settled, start building some savings and, ideally, use your new degree to find a more lucrative job.
While many federal student loans do offer a grace period, private student lenders often do not. This means that even if you’re lucky enough that your bank, credit union or other private lender doesn’t ask you to begin paying back your debt while you’re still a student, you should plan to start making those payments right away once you graduate.
A Choice of Repayment Plans
When you do start repaying your college debt, it helps to have options. Recent graduates sometimes struggle to afford large monthly student loan payments, particularly in tough economic times when it can be difficult to find a full-time job.
To make loan repayments more manageable, the federal government offers eight different repayment plans. You can choose whether to pay your loan off in 10 years or in 25 years. If you’re not making much money early on after you leave school, then you could choose a graduated payment plan, in which payments start small but increase over time, or an income-based repayment plan, which reduces your monthly minimum payment amount to fit your income. Your financial status can change a great deal over the years that follow graduation, so the federal government allows borrowers to select a different repayment plan at any time, without any fees or penalties for doing so.
If you want to save money by paying your loans off earlier – and thus accruing less interest – you can. With federal student loans, borrowers don’t have to worry about incurring prepayment fees.
You can also opt into an automatic payment plan that allows your loan servicer to automatically withdrawal your student loan payment from your account each month. There are a number of benefits to enrolling in autopay. You no longer have to worry about late payments or incurring late fees. Often, you can reduce your interest rate if you choose automatic payments. The decrease in interest rates is usually small, but still, it saves you some money and some hassle.
Private lenders aren’t required to give borrowers options when it comes to loan repayment. They don’t have to offer you alternative repayment plans based on your income. If you choose to pay more than the minimum amount so you can pay down your debt faster, you could be penalized for it. While they may offer automatic payment options, too, they don’t have to – and they’re not required to reduce your interest rate for enrolling in an automatic payment program.
Ultimately, federal student loans allow borrowers far more flexibility when it comes to loan repayments.
A Tax Break on Your Student Loan Interest
If you’re really feeling the financial sting of having to pay thousands of dollars in student loan interest per year, there’s some good news. Unlike typical private student loans, federal student loans will often allow you to deduct the interest you paid throughout the year from your taxes.
There are limitations to this benefit. Your modified adjusted gross income must be under $80,000 annually to claim this deduction, and you can only deduct up to $2,500 per tax year, the Internal Revenue Service (IRS) reported. However, that means many borrowers will get to write off a good chunk of the interest they have paid – and ultimately, keep more of their money.
The Option to Consolidate
If you have to take out student loans for each year of your college education – and many student borrowers do – then you’ll end up having numerous loans. These loans can have different interest rates and even different lenders or loan servicers, which can mean that making your monthly payments is a hassle. For some borrowers, it makes sense to consolidate all of your student loans into one bill with a fixed interest rate.
If you took out your loans from the U.S. Department of Education, the federal government allows you to apply for a Direct Consolidation Loan without paying any application fees or other costs to do so. On the other hand private student loans aren’t eligible for integration into a Direct Consolidation Loan, Federal Student Aid reported.
Deferment and Forbearance Options
Do you think that going into default is the only option when you’re struggling to pay your college debt? It’s not – especially when you used federal student loans to fund your education.
The federal government allows borrowers who have trouble repaying their student loans to temporarily stop making payments by applying for deferment or forbearance.
Deferment is simply the postponement of paying your college loans. If you had Direct Subsidized Loans, Subsidized Federal Stafford Loans or Federal Perkins Loans, you will also stop accruing interest during this time. Students who took out Direct Unsubsidized Loans, Unsubsidized Federal Stafford Loans and Direct PLUS Loans can stop making payments while their loans are in deferment, but they will continue to accrue interest. When federal student loans are in forbearance, you will keep incurring interest charges no matter which kind of loan you have.
Of course, if you’re really struggling, that’s still better than private student loans. Private lenders often offer no deferment, forbearance or other options that would allow you to stop making payments for even a short time.
The Possibility of Loan Forgiveness
Typically, once you take out a student loan, you’re responsible for repaying that money plus the interest. However, some federal student loans can be forgiven, or the balance wiped clean. Professionals working in public service and education may be eligible for student loan forgiveness, according to Federal Student Aid. In most cases, student loan forgiveness isn’t an option under any circumstances when you borrowed from private lenders.
No-Cost Student Loan Help
If you really are struggling to make your student loan payments, then how much help is available to you can make all the difference. Let’s face it – if you can’t afford your student loan payments, then you can’t afford to pay for help, either.
The federal government offers student borrowers help for free online or by phone at 1-800-4-FED-AID. Getting help for problems with private student loans can be far more difficult. You may need to contact the Consumer Financial Protection Bureau’s private student loan ombudsman – a neutral appointed official who can help resolve billing disputes – for assistance if you can’t get your lender to work with you.
With so many advantages of federal student loans, it’s clear that most students are better off seeking government funding for college rather than applying for loans from private banks. At every point in the process, from applying for loans to repaying your debt and getting help for issues, federal student loans offer more benefits and more flexibility than private student loans do.