Differences Between Federal and Private Student Loans

For many students, the idea of taking out a student loan is scary and difficult. With all of the different options out there, it's hard to know how to go about applying for a loan or what type of loan you'll need.

There are two different types of student loans: federal and private. Federal student loans are made for post-secondary education and are issued by a federal agency. The Department of Education controls most federal student loans. A private student loan is a loan made by the bank or credit union to pay for the costs of post-secondary education. Here are some of the major differences between federal and private student loans:

Federal Loans Tend to Have a Fixed Interest Rate

Federal student loans tend to have lower interest rates than private loans, and the interest rate on a federal loan is often fixed. Although federal loan interest rates may change or vary, they are capped at 8.25%. Private lenders have no such regulations. Private student loans can have variable interest rates, and the interest rate for a private loan is usually much higher than a federal loan, sometimes as high as 18%. A variable interest rate may substantially increase the interest you pay on your loan.

Private Loans Are Not as Flexible in Terms of Repayment

Compared to federal loans, private loans are not as flexible in terms of repayment. When it comes time to start repaying your federal student loans, there are several different repayment options. With a federal loan, you can choose an income-based payment or you can suspend payments if you lose your job. Private lenders may allow you to defer or forbear your loans, but these options are often limited.

Federal Loans Can Be Consolidated

If you have multiple federal loans, you have the option to consolidate your loans into one loan. Consolidating your student loans into one can make your life easier by giving you one monthly payment and a lower interest rate. While you have the option to consolidate your federal loans, with private loans you are often stuck with multiple loans. Each of these loans may have different interest rates and different monthly payments, making it harder to manage. The reason private lenders don't allow consolidation is because private loan interest rates depend on the borrower's credit score. Although a good score can lead to a lower rate, it's not guaranteed.

Private Loans Can Help Cover the Entire Cost of Tuition

If federal loans don't cover the entire cost of your tuition, you can make up the cost difference in private loans. Many borrowers view this as a benefit, however, it can have serious consequences in the long run. Many young students don't fully understand the consequences of borrowing large amounts of money and how difficult repayment can be when there are different types of loans involved.

Before signing loan paperwork, it's important to do your research and to ask as many questions as possible. Clearly knowing your options and the terms of your loans can help you make an informed decision, which can also greatly reduce your frustration in the future.