4 Differences between Private and Federal Student Loans

Differences between private and federal student loans

Is the cost of college on the rise? You probably already know the answer to that question! But the exponential rate at which college cost is increasing may shock you.

According to the National and Regional Trends in College Tuition study published by DePaul University in 2001, when taking inflation into account “the average tuition of the nation’s 4-year public institutions increased by nearly 128 percent” between 1980 and 2001. And costs have certainly not stopped rising in the last ten years.  It’s no surprise, then, that more and more students have had to turn to loans in order to cover their tuition and other expenses.

And while families have begun to absorb more information about the student loan processes and terms, there are still areas where confusion exists.

One major misconception, for example, is that federal loans and private loans are similar, since they both cover the cost of college and need to be paid back after graduation. Wrong! On the contrary, the best plan is to always exhaust federal loan options before turning to private loans. Here are just four (of the many) reasons why that’s true:

1. Private student loans are not as flexible in terms of repayment as compared to federal loans. Private lenders might allow you to defer or forbear your loans, but these options are limited and not required. When repaying a federal loan, however, you are able to suspend payments if you lose a job and generally can negotiate various forbearance or deferment plans for a period of time as needed.

2. Private loans can cover up to the entire cost of tuition. Many borrowers view this as a benefit of private loans — whatever one cannot borrow through federal loans they can just make up for in private loans. However, in the long run, this can have terrible consequences: students can borrow upwards of $50,000, $80,000 and $200,000 (gasp) to cover the full cost of tuition. Many young students don’t totally understand the consequences of borrowing such large amounts and how huge of a problem repayment can then be.

3. Private student loans usually have variable interest rates that can, and usually do, fluctuate throughout the life of the loan. Federal loan interest rates, on the other hand, may change or vary, but are capped at 8.25%. Private lenders have no such regulation. In “An Education in Student Loans,” David A. Graham describes Tyrone Bailey, a student with $20,000 in student loan debt… at 18% interest. That sounds a lot more like a credit card! In fact, private loans act so much like credit cards that they sometimes charge introductory low interest rates, but then raise these rates with little to no warning. Graham goes on to detail how direct school-to-student loans have gotten away with charging interest rates as high as 18% and more.

4. Private loans usually can’t be consolidated. Consolidating, or combining, all your loans into one can make your life easier, with one typically low interest rate and just one payment per month. While federal loans can be consolidated, with private loans you’re generally stuck with multiple loans, each having different interest rates and different monthly payments across the board. The reason private lenders do not allow consolidation is that private loan interest rates depend on the borrower’s credit score. A good credit score can lead to a lower rate, but it’s not guaranteed.

It is always a good idea to do your research and ask as many questions as possible. Clearly knowing the terms of your loans can help you make an informed decision, which can also save you years of frustration in repayment. Also, don’t forget to utilize some really great online resources, like alltuition, FinAid.org, and the government’s own Student Loans site, for help with financial aid and navigating student loan options. Good luck!

This article is part of our Student Loan Debt Resource Center.  If you’re looking for additional information about student loans, be sure to pay a visit!

Kelli Space is a 2009 graduate of Northeastern University and a student loan advocate. She created the site twohundredthou.com to solicit help with her hefty monthly payments. You can follow her on Twitter at @twohundredthou.

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  • Guest

    Just wanted to thank you for this article, I’m relatively new to the post grad life – two years now.  And between this article and the one about the special direct consolidation, it’s been very helpful.  I am managing relatively well, but I am about to consolidate.  So thanks!

    • I’m glad you liked the two articles! Have you tried using ReadyForZero to help manage your student loans? If so, we’d love to hear how it’s going for you.