Students should borrow federal first, because federal student loans offer superior benefits as compared with private student loans. Federal student loans are better than private student loans. Parent loans and private student loans should be considered only after the student has reached the loan limits on federal student loans.
Federal student loans are superior to private student loans in more than a dozen ways.
- Federal student loans do not require cosigners. More than 90% of private student loans to undergraduate students and more than 75% of private student loans to graduate students require a creditworthy cosigner.
- Federal student loans do not depend on the borrower’s credit scores or debt-to-income ratios. Eligibility for most private student loans requires a review of the credit history of the borrower and cosigner (if any) and consideration of credit scores and debt-to-income ratios.
- Borrowers of federal student loans must submit the Free Application for Federal Student Aid (FAFSA). The FAFSA is not required for private student loans.
- Annual and aggregate limits for federal student loans are set by law. Loan limits for private student loans vary by lender.
- Federal student loans are available through the college’s financial aid office and are made by the U.S. Department of Education. Private student loans are made by banks, credit unions and other financial institutions.
- Federal student loans are less expensive than private student loans.
- Federal student loans offer low fixed interest rates. Private student loans offer fixed interest rates or variable interest rates or both.
- Interest rates on federal student loans are the same for all borrowers, regardless of credit history. Interest rates on private student loans depend on the credit scores of the borrower and the cosigner (if any). A lower credit score yields a higher interest rate on a private student loan.
- The fixed interest rates on federal student loans are lower than the fixed interest rates on most private student loans.
- The variable interest rates offered by some private student loans may start off lower than the fixed rates on federal student loans, but ultimately will be more expensive as interest rates rise over the life of the loan.
- Accrued but unpaid interest on federal student loans is capitalized once, when the loan enters repayment. Interest capitalization on private student loans may occur as frequently as monthly.
- The interest on both federal and private student loans is eligible for the student loan interest deduction.
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- Federal student loans offer deferments and forbearances, which suspend the repayment obligation for up to three years each. Private student loans offer a maximum of a one-year forbearance.
- The federal government pays the interest on subsidized Federal Direct Stafford loans during a deferment but not during a forbearance. Private student loans do not offer deferments, but often use the terms deferment and forbearance interchangeably.
- Some private student loans require interest-only or fixed payments during the in-school and grace periods for borrowers to obtain lower interest rates.
- Federal student loans offer income-driven repayment plans. Most private student loans do not offer income-driven repayment plans. The main exception is Rhode Island.
- Federal student loans offer extended repayment. Most fixed-rate private student loans do not allow borrowers to increase the repayment term, as this increases the lender’s cost of funds in a rising-rate environment. Variable-rate private student loans, on the other hand, may be more flexible in allowing borrowers to switch to an extended repayment plan, since the spread between the borrower interest rates and the lender’s cost of funds is constant.
- Borrowers of a Federal Parent PLUS Loan can defer repayment while the student is enrolled at least half-time and for 6 months after graduation, as an alternative to immediate repayment. Most private parent loans require payments to begin while the student is still in school, but may offer smaller fixed or interest-only payments as an option.
- Both federal and private student loans do not have prepayment penalties, so nothing stops a borrower from making extra payments to pay off their student loans quicker.
- Default on a private student loan requires 120 days of non-payment, compared with 270 days of non-payment on a federal student loan.
Discharge and Forgiveness
- Federal student loans offer death and disability discharges. Some private student loans do not offer death and disability discharges. Private student loans are more likely to offer a death discharge than a disability discharge.
- Federal student loans offer a variety of loan forgiveness options, such as teacher loan forgiveness and public service loan forgiveness. Private student loans do not offer forgiveness options.