For most families, student loans are a big part of financing a college education. While student loans are quite easy to get, they aren’t as easy to understand. There are so many payment plans, variable interest rates, consolidation, and other options that muddy the waters.
One common source of confusion is the difference between private and federal student loans. While they might seem to be very similar, the differences go far beyond the source of the funding. Federal student loans are advantageous in every conceivable way.
Understanding the differences between private and federal student loans can save you thousands of dollars.
Consider These Differences:
1. The Government Funds Federal Student Loans
Banks fund private student loans. That’s the first difference. Taxpayers and the federal government support federal student loans. Private student loans are a moneymaking tool for banks. This alone is a clue about which type of loan is preferable.
2. Federal Student Loans Will Normally Have A Fixed Interest Rate
The interest rate is determined before the loan is made, and the student will pay that rate over the lifetime of the loan. These interest rates are quite low. The same can’t be said of private loans.
Private loans will normally have higher interest rates. The interest rate on private loans can frequently rise to over 10%.
Private loans can also have variable interest rates that fluctuate with the market.
These factors associated with private loans can end up being very expensive.
3. Some Federal Student Loans Won’t Start Accruing Interest Until After Graduation
Federal student loans are interest free until graduation, while other federal loans and all private loans start charging interest as soon as the check is cashed.
Four years of accrued interest really adds up. This is a huge advantage of subsidized Stafford Loans.
You can usually deduct interest from federal loans on your tax return. This normally isn’t true for private loans. While this typically isn’t a lot of money, every little bit helps.
4. Federal Student Loans Aren’t Required To Be Repaid Until After Graduation
Most private loans require that repayment start immediately. It can be interest only or a regular loan payment depending on the terms of the loan.
Life as a college student is usually financially challenging. Imagine having to make a loan payment, too.
5. Some Private Loans Will Penalize You For Paying Ahead On Your Loan
Banks want all the interest they can get, so many won’t allow you to pay ahead. All federal loans permit early repayment. A prepayment penalty isn’t something you want with your loan.
6. Federal Loans Have Better Features Than Most Private Loans
These features include things like forbearance, deferment, and consolidation. Federal loans also have options that can retire at least part of your student loan debt, like volunteering for the Peace Corp.
7. Federal Student Loans Are Retired At Death
If you die before your student loan is paid off, the debt is retired. This isn’t the case with private student loans, and that’s part of the reason that most private student loans require a cosigner. Federal student loans can also be cancelled if you suffer a serious disability.
As you can see, private student loans are costly and less flexible. Federal student loans are the sensible choice because they are much more affordable. Federal loans exist to help you go to college, whereas private student loans exist to make money for the bank.
The differences between federal and private student loans are considerable. Exhaust all other financing options before getting any student loans. Only use private student loans as a last resort for financing your education. Federal student loan offerings are much more attractive in every possible way.