College Loans: Private Vs. Federal

By Katie Adams AAA

Paying for college is a top financial priority for many people, but the ever-increasing cost for higher education is beyond many people's financial reach. When you don't have savings or investments to cover the cost of your children's college education, you may need to investigate loan options.

TUTORIAL: Student Loans

Federal Loans
Federal college loans are loans that the federal government funds to help students or parents pay for the cost of a college education. (Save thousands of dollars on tuition with these tricks and little-known programs, see Pay For College Without Selling A Kidney.)

Types of FederalCollege Loans
There are three types of federal loans: the Federal Perkins Loan, the Federal PLUS Loan and Federal Stafford Loans. To qualify for a federal loan, you will need to complete and submit a free application of student aid (FAFSA) form to the U.S. Department of Education (DoED). The DoED uses the FAFSA form to determine your expected family contribution (EFC), or how much your family will be required to pay towards the college bill. Your school's financial aid office can help explain the FAFSA form and the different types of federal loans that you or your student may qualify for.

Federal Perkins Loan
The Perkins Loan is a need-based loan for applicants with little income and assets. More than 4,000 colleges and universities participate in the Perkins Loan program. Schools help, in part, to determine a student's financial need and how much money will be awarded to the applicant. It can be a helpful financial tool for needy students and offers several benefits to alternate financing tools including a low, fixed rate of interest; potential loan cancellation for borrowers who go into certain military, public or teaching professions upon graduation; no loan fees and a longer grace period before repayment is required. Borrowers must be U.S. citizens, permanent residents or be eligible for non-citizen status; must be enrolled at least half-time in a degree program and must maintain acceptable academic standards. Funds will be sent to the applicant or applied directly to the student's tuition. (Find out what to do when your kid is ready for higher education, but you aren't - check out Last Minute Strategies To Help Pay For College.)

Federal Stafford Loans
Stafford Loans are perhaps the most well-known federal college loans. There are four types of Stafford loans:

  • Staffordsubsidized direct loan
  • Stafford unsubsidized direct loan
  • Stafford subsidized Federal Family Education Loan (FFEL)
  • Stafford unsubsidized FFEL

The primary difference between Stafford Direct Loans and a Stafford FFEL is that you, as a borrower, apply for and receive FFEL funds from a private lender (banks, credit unions, etc.) and you will make loan payments to that private lender, whereas you apply for direct loan funds directly from the federal government and you make loan payments to the DoED.

Subsidized Stafford Loans are need-based, meaning that applicants must demonstrate financial need. Your financial need is determined by subtracting your EFC and other sources of financial aid from the cost of your college education. The loans are called subsidized because the government subsidizes the interest on the loan while you are enrolled at least half-time or graduate - you are not charged interest on your loan until then, and you have a six-month grace period after leaving school before you need to begin making payments on the loan. If your loan is deferred, you will not be charged interest during that period of time. (Extending your principal repayment date can increase your chances of fighting off default, read Student Loan Deferment: Live To Pay Another Day.)

Unsubsidized Stafford Loans are not given on the basis of financial need. Interest charged on the loan amount begins accruing from the time you receive funds until it is repaid in full.

Students applying independently for a Stafford Loan (as opposed to a parent applying for funds on a dependent child's behalf) have a higher annual loan limit and can qualify for a higher amount of unsubsidized funds.

There are several attractive benefits to obtaining a Stafford Loan, including:

  • no need to pass a credit check
  • a low, fixed-rate of interest
  • several flexible repayment plans
  • no penalty for prepaying the loan

(These savings vehicles may be better than college saving funds for some families, check out Pay For A College Education With Retirement Funds.)

However, there are factors to consider before applying for Stafford funds, including:

  • low amount limits
  • requirement to file a FAFSA form
  • requirement to apply for funds each academic year
  • limits on how you can use funds
  • student must remain enrolled at least half-time to qualify for, and continue receiving funds
  • small loan fee

Federal PLUS Loan
The PLUS Loan is a loan designed for parents of college students. Like Stafford Loans, there are direct PLUS Loan and FFEL PLUS Loan options. The PLUS Loan offers parents several attractive loan features including that applicants can borrow the full cost of college (minus any financial aid or scholarships earned); it carries a low, fixed rate of interest and it offers flexible repayment plans including the ability to defer payment until after your student graduates or drops below part-time enrollment status. However, the PLUS Loan does require that, in addition to filing a FAFSA form, parent applicants must pass a credit check (or obtain a cosigner or endorser) and apply for funds each academic year. (This legislation can help families pay college costs and reduce student debt, see College Cost Reduction Act Helps Students Meet Payments.)

Private Loans
Private loans are loans you can obtain from banks, credit unions or other lending institutions to help cover college expenses not met by scholarships, grants, federal loans or other types of financial assistance. Most private loans are made directly to students, meaning that it becomes their financial and legal responsibility to repay the loan. (When federal student loan resources are exhausted, parents and students face tough decisions on how to pay, read Should Parents Pay For College?)

You can apply for a private loan at any time and use the loan proceeds towards college expenses in addition to tuition (books, computer, transportation).

The Pros of Private Loans
There are several reasons why private loans are attractive college financing options, including:

  • easy application process (typically you can apply for a loan online or by phone - no in-person meetings are necessary)
  • most loans do not require you to complete a FAFSA form for federal aid
  • loan funds are made available immediately upon approval
  • cosigner options are generally available
  • interest on a private loan may be tax-deductible
  • most loans do not include a prepayment penalty and charge low, if any, fees

Possible Cons of Private Loans
There are a few potential downsides to consider before applying for a private loan for college. Most lenders will require that you pass a credit check. However, if you do not have a sufficient credit history to qualify for the loan you may be able to get a cosigner. Also, private loans typically charge a higher interest rate than federal loans, so the size of the loan can have some bearing on your choice in lender. Finally, funding must be applied for every academic year - just because you're approved this year is no indication of your loan status for next year. (Don't let these excuses prevent you from reaching your financial goals, see Debunking 10 Budget Myths.)

The Bottom Line
Because private lenders typically charge a higher interest rate, it's a good idea to explore other, less expensive forms of financing first including grants, scholarships, work-study programs and federal loans.

College payments are going to be a substantial investment into the future of an individual. Schooling decisions go beyond just the financial numbers and move into the territory of bettering one's self. Even so, finances cannot be ignored. Exploring your options can save headaches and money now and in the future.

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