Which is the best to borrow?

ByRichard C. Sloan

Apr 1, 2022

Tero Vesalainen/Getty Images/iStockphoto

If you’re thinking of borrowing money for college, you’ll have plenty of company. Nearly 45 million Americans hold $1.71 trillion in student loans. Before taking on what could be decades of debt, it’s important to understand the many key differences between your two main choices: federal student loans and private student loans.

Read more: What to do if you can’t afford to pay off your student loan
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Live Richer podcast: Advice from the Ramsey Solutions team on battling student loans

Federal vs. Private Student Loans – What’s the Difference?

Federal and private student loans must be repaid with interest whether or not you have graduated from college. The interest you pay on both types of loans may be tax deductible. Beyond that, the differences outweigh the similarities.

The main distinction is that the federal government funds federal student loans, and lenders like credit unions, banks, state agencies, and colleges fund private student loans themselves.

There are four types of federal student loans:

  • Subsidized direct loans: These loans offer better rates to undergraduate students who can demonstrate the need.

  • Direct unsubsidized loans: Undergraduate and graduate students can apply without having to demonstrate need.

  • Graduate Loans PLUS: These are specifically aimed at graduate and professional students.

  • Parent PLUS Loans: These are special loans granted to the parents of a student.

Apply for Federal Loans First

One of the other key differences is that you must apply for federal student loans through the Free Application for Federal Student Aid (FAFSA). The deadline for submitting all FAFSA documents for the 2021-2022 academic year is 11:59 p.m. Central Time on June 30. All updates and fixes are due by September 10. Time June 30, 2023, and all updates and corrections are due no later than September 10, 2023. The FAFSA determines your borrowing limit, which may not cover attendance fees, and the FAFSA also determines your eligibility to other government assistance such as work-study and grants.

With private loans, on the other hand, you apply directly to the lender and the lender determines your borrowing limit regardless of need. In most cases, a co-signer with good credit will help students secure private loans. This is not the case with federal loans.

Generally speaking, you should only consider private loans after you have exhausted not only federal loans, but also grants, scholarships, and other awards. That’s partly because, unlike FAFSA deadlines, you can apply for private loans as late as you want, as long as the lender has enough time to process the loan. More importantly, you should line up with federal loans first, as they tend to be more flexible, simpler, and more affordable than private student loans, which you should generally only use to fill funding gaps at the end. .

There’s a lot to love about federal student loans

With private loans, the lender sets the terms and conditions, which vary from loan to loan, lender to lender and borrower to borrower. With federal student loans, on the other hand, the terms and conditions are set by law and never change. Not only are federal loans generally cheaper — the current rate is 3.73% — but they offer a slew of perks and benefits that most private loans can’t match, including:

  • Fixed interest rates, as opposed to private loans, which can charge fixed or variable rate interest.

  • Income-based repayment plans, which adjust your monthly payment based on what you earn.

  • Deferred payments, which you don’t have to start making until you graduate. Private loans can be deferred, but in many cases you must start paying while you are still in school.

  • Subsidy — If you can show you need it, the government will pay your interest while you’re in school. Private loans, on the other hand, are never subsidized.

  • With the exception of PLUS loans, there is no credit check with a federal student loan. In almost all cases, private lenders will check your credit and set your rate accordingly.

  • Several federal loans can be consolidated into a single fixed rate direct consolidation loan. Private student loans cannot, although they can be refinanced.

  • With federal loans, students can change their repayment plans even after finalizing their loan.

  • Students who work in the public service could see part of their federal loans canceled.

Loans to parents are somewhere in between

One of two types of Direct PLUS loans, Parent PLUS loans have some, but not all, of the benefits of federal student loans. For example, parents who borrow money through these federal loans can defer payments until their child leaves school, as if the student had taken out the loan.

Although the interest rate is fixed like a student loan, parent loans are never subsidized – the borrower is responsible for all interest. This interest, however, is usually still tax deductible and multiple loans can be combined into one direct consolidation loan. Like students, parents who work in the public service may also have some of their loans forgiven.

More from GOBankingRates

This article originally appeared on GOBankingRates.com: Comparing Private and Federal Student Loans: Which is Best to Borrow?