Private vs. Federal College Loans: An Overview
While a college education is a priority for many people, the ever-increasing cost threatens to push it out of financial reach. If you don't have the savings to cover the cost of a college education, check out loan options.
- You can obtain a student loan through the federal government or private lenders.
- Federal loans generally have more favorable terms, including flexible repayment options.
- Students with "exceptional financial need" may qualify for subsidized federal loans while unsubsidized loans are available regardless of financial need.
- The interest is usually lower and has been suspended because of the COVID-19 pandemic.
- The White House announced debt relief for certain federal student loan borrowers.
Private college loans can come from many sources, including banks, credit unions, and other financial institutions. You can apply for a private loan at any time and use the money for whichever expenses you wish, including tuition, room and board, books, computers, transportation, and living expenses.
Unlike some federal loans, private loans are not based on a borrower's financial needs. In fact, you may have to pass a credit check to prove your creditworthiness. If you have little or no credit history, or a poor one, you might need a cosigner on the loan.
Borrowers should remember that private loans often come with higher borrowing limits when compared to federal loans. The repayment period for student loans from private lenders may also be different. While some may allow you to defer payments until after you graduate, many lenders require you to begin repaying your debt as you attend school.
Federal student loans are administered by the U.S. Department of Education. They tend to have lower interest rates and more flexible repayment plans than private loans. To qualify for a federal loan, you will need to complete and submit the government's Free Application for Federal Student Aid (FAFSA).
The FAFSA asks a series of questions about the student's and parent's income and investments, as well as other relevant matters, such as whether the family has other children in college. Using that information, the FAFSA determines your Expected Family Contribution (EFC). That figure is used to calculate how much assistance you're eligible to receive.
The confusingly-named EFC has been renamed the Student Aid Index (SAI) to clarify its meaning. It does not indicate how much the student must pay the college. It is used to calculate how much student aid the applicant is eligible to receive. The relabeling will be implemented by the 2024-2025 school year.
The financial aid offices at colleges and universities decide how much aid to offer by subtracting your EFC from their cost of attendance (COA). The cost of attendance includes tuition, required fees, room and board, textbooks, and other expenses.
To help make up the gap between what a particular college costs and what that family can afford to pay, the financial aid office puts together an aid package. That package might include some combination of federal Pell Grants, federal loans, and paid work-study jobs.
Schools can also draw on their own resources to offer—for example, merit scholarships. The fundamental difference between grants and loans is that grants never have to be paid back (except in rare instances), while loans eventually do.
The federal government made provisions to help student loan borrowers during the COVID-19 pandemic. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was passed in March 2020, initiated forbearance on all federal student loans. The Biden administration extended it to Dec. 31, 2022. It was later extended again.
The White House also announced other key provisions that would help and protect student loan borrowers regarding their federal student loans. These include:
- Debt cancellation: Borrowers get up to $20,000 forgiven if they have Pell Grants from the Department of Education or up to $10,000 forgiven if they don't have Pell Grants. There are income requirements, though. Borrowers with annual incomes that exceed $125,000 ($250,000 for married couples) don't qualify.
- Making changes to the student loan system by slashing monthly payments for undergraduate student loans in half and allowing loan forgiveness credit for certain borrowers like military personnel and civil servants.
Federal courts have issued orders blocking the student loan forgiveness plan. Consequently, as of Nov. 11, 2022, the Department of Education is no longer accepting applications for student loan forgiveness. After the courts blocked the program, the White House extended forbearance on student loan repayments until the earlier of either:
- 60 days after the Department of Education is permitted to implement the loan forgiveness program, or litigation regarding the program is resolved; or
- 60 days after June 30, 2023.
There are also plans in the works to try to make community college free while doubling the number of Pell Grants for students. The White House also aims to hold institutions accountable for raising tuition rates in an attempt to make higher education more affordable.
It's important to note that these changes only apply to federal student loans—not to private loans. Borrowers who need help with their private loans should approach their lenders for any provisions they may offer.
Types of Federal Loans
The William D. Ford Federal Direct Loan program is the largest and best-known of all federal student loan programs. These loans are sometimes referred to as Stafford loans, the name of an earlier program. There are four basic types of federal direct loans:
- Direct subsidized loan
- Direct unsubsidized loan
- Direct PLUS loan
- Direct consolidation loan
Note that a provision in the American Rescue Plan makes all student loan forgiveness tax-free from Jan. 1, 2021, to Dec. 31, 2025.
Direct Subsidized Loans
These loans are given to students depending on their financial need. The government subsidizes the interest on the loan while the student is enrolled at least half-time. You are not charged interest on subsidized loans until you graduate, and you then have a six-month grace period after leaving school before you need to begin making loan payments. If your loan is deferred, you will not be charged interest during that period of time.
Direct Unsubsidized Loans
Unsubsidized loans are available to students regardless of financial need. Unlike subsidized loans, their interest begins accruing as soon as you receive the funds and continues until the loan is repaid in full.
Independent students who apply for a direct loan (as opposed to dependent students applying with their parents) can qualify for a higher amount of unsubsidized funds.
Direct loans have several attractive benefits, including:
- No need to pass a credit check
- A low, fixed rate of interest (because private loans often have variable rates)
- Several flexible repayment plans
- No penalty for prepaying the loan
However, they also have some downsides, such as:
- Low loan limits
- The need to file a new FAFSA form every year to maintain eligibility
- Stricter limits on how you can use the money than with private loans
Direct PLUS Loans
PLUS loans are designed for the parents of college students and are not based on financial needs. They have a number of appealing features, including the possibility of borrowing the full cost of attendance (minus any other financial aid or scholarships).
They also carry a relatively low, fixed rate of interest (but higher than the rates on other direct loan types) and offer flexible repayment plans, such as the ability to defer payment until the student graduates.
PLUS loans do require that the parent applicant pass a credit check (or obtain a cosigner or endorser) and reapply for funds each academic year. The parent is also legally responsible for repaying the loan.
In addition to the parents of undergraduate students, PLUS loans are available to graduate and professional students.
Direct Consolidation Loans
When it comes time to repay student loans, the government offers direct consolidation loans, which you can use to combine two or more federal education loans into a single loan with a fixed interest rate based on the average rate of the loans you are consolidating.
You can't consolidate private loans using the federal program, but private lenders can consolidate your loans, both private and federal, by paying off your old loans and issuing you a new one. This is often referred to as refinancing.
Refinancing with a private lender can get you a lower interest rate in some cases, but you'll lose the flexible repayment options and consumer protections that come with federal loans. If you have both federal and private loans, it makes sense to consolidate the federal ones through the government program and refinance the others with a private lender.
Frequently Asked Questions
What Are the Differences Between Federal and Private College Loans?
Private college loans come from sources such as banks, credit unions, and other financial institutions. Federal student loans, administered by the U.S. Department of Education, usually have lower interest rates and more flexible repayment plans.
What Are the Basics of Private College Loans?
Private loans, unlike those from the government, aren't based on financial need. Borrowers may have to pass a credit check to prove their creditworthiness. Borrowers with little or no credit history, or a poor score, may need a cosigner on the loan. Private loans may also have higher borrowing limits than federal loans.
How Do You Borrow College Money Under Federal Loan Programs?
To qualify for a federal loan, you will need to complete and submit the Free Application for Federal Student Aid, or FAFSA. Borrowers must answer questions about the student's and parent's income and investments, in addition to other relevant matters, such as whether the family has other children in college. Using that information, the FAFSA determines the Expected Family Contribution, which is being rebranded as the Student Aid Index. That figure is used to calculate how much assistance you're eligible to receive.
The Bottom Line
Loans are among the resources available to help students and their families pay college bills. Private and federal loans have their advantages and disadvantages, depending on your situation.
Private loans, administered by banks and credit unions, are much like any other kind of loan, meaning a credit check will be required. Federal loans are often needs-based with lower interest rates and flexibility in repayment. Those who do the required legwork will find options that best meet their needs.