Private vs. federal student loans: the pros and cons


The average annual tuition for an in-state public college is around $20,000, and for a private college it’s $44,000. That’s 3 percent higher than a year ago, so chances are you’re going to need a little assistance to cover it. Part-time jobs, scholarships, and family support are helpful, but where can you get the rest of the money? For many college students today, the answer is federal and private student loans. We’ve broken down the pros and cons of each.

Federal student loans

The federal government offers subsidized and unsubsidized student loans to eligible students. The government will pay for, or subsidize, the interest on subsidized loans while the student is in college. The interest on unsubsidized loans, on the other hand, begins accruing after the first disbursement.

The pros of federal student loans
  1. Federal loans have fixed interest rates
    In other words, the government can’t tell you you’re paying an 8 percent interest rate one year and then hike it up to 12 percent the next. In fact, federal Direct Subsidized Loans and Direct Unsubsidized Loans have low interest rates that keep the repayment process manageable and predictable.
  2. The government may pay your interest while you’re in college
    If you’re eligible for a subsidized student loan, the government will pay the interest while you’re in college, which is a significant savings. Eligibility for these loans is based on financial need, which is determined by the information on your FAFSA.
  3. Flexible repayment plans
    Federal student loans offer a variety of repayment plans, allowing you to customize your monthly payment and repayment term.
  4. You may be able to delay repayment
    Under certain circumstances, like unemployment or economic hardship, you may be able to temporarily delay the repayment of your federal student loans.
  5. The government can’t take all of your income to repay the loan
    The amount of your monthly payment can never be more than a certain percentage of your current income. So if your income decreases, you can request a reduced monthly payment.
The cons of federal student loans
  1. The government can garnish your salary if you default on your loan
    If you default (fail to pay) on your loan, the government has the authority to garnish (take money out of) your wages.
  2. Defaulting can also lead to the loss of other sources of income
    If you default on your loan, the government may also garnish income tax refunds and social security benefits. In addition, defaulting on a loan will negatively impact your credit rating.
  3. There is a cap on how much money the government can loan you
    Depending on your dependency status and year in school, there is a maximum annual loan limit of $5,500-$7,500 for dependent students (students still dependent on the income of a parent or guardian) and $9,500-$12,500 for independent students. For graduate or professional students there is a borrowing limit of $20,500 per year.
  4. Federal student loans may not be enough to completely cover college costs
    When you consider the total cost of college including tuition and fees, room and board, books, supplies, transportation, and personal expenses you may need more than your federal student loan award to cover your costs. That’s when private student loans may become necessary.

Private student loans

Private loans are any loans provided by a non-federal lender, such as a bank, credit union, school, or state agency.

The pros of private student loans
  1. Borrow up to the cost of education
    While the federal Direct Loan Program has an annual maximum amount that can be borrowed, most private lenders allow students to borrow up to the total cost of their education. Typically, lenders establish a process for your school to confirm the amount is accurate before funds are sent to the school. Loan limits vary from lender to lender and may vary between undergraduate and graduate loans.
  2. All lending institutions are required to disclose fully
    All lending institutions are regulated and must be honest about the amount of debt you are taking on and the interest rates you should expect to have for the life of the loan.
  3. Interest rates are based on credit
    Most private student loan lenders offer a range of interest rates for their products and the actual rate a borrower receives is based on the applicant’s credit information. With excellent credit, you may be able to receive better interest rates than what is offered in the federal Direct Loan Program.
  4. Borrowing student loans from your own bank
    You may be able to take out a student loan from a bank you already have a relationship with. Many private banking institutions offer private student loans, and some banks offer interest rate reductions for borrowers that have an existing relationship with their company.
The cons of private student loans
  1. Variable interest rates have the potential to change
    As opposed to the fixed interest rates carried by federal student loans, private lenders may offer a variable rate where the interest rate can change over the course of a year, depending on the variable index the lender uses. For example, the one-month LIBOR is typically used for variable rate loans, which means the rate could potentially change from month to month.
  2. The interest rate may be higher
    Private student loans may offer a higher average interest rate than federal student loans, depending on your credit. If you have excellent credit, try doing a side-by-side analysis of rates to determine which option is best for you.

So which one should I choose?

When it comes to student loans, less is more. The best rule of thumb is to try to take out the least amount in student loans at the lowest interest rate.

  1. First, apply for as much “free money” as possible, in the form of grants and scholarships.
  2. Then, if grants and scholarships aren’t enough to cover all of your college expenses, federal student loans may be your next option.
  3. Finally, if the additional money awarded through federal student loans still don’t cover all of your expenses, you may then want to consider adding a private student loan to finance the deficit.

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