Federal or Private Student Loans? How to Choose the One For You

One of the biggest expenses that many Americans face is college tuition, which has skyrocketed over the last several years. Ironically, it’s the easy access to student loans that has been one of the major culprits fueling this rise in cost. If you choose to go to university, you are often stuck with a large bill, one that most people cannot afford without some type of financing. In this article, we will try to look at some crucial differences between using federal or private student loans.

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Differences in Repayment Schedules

One of the crucial advantages of a federal student loan is that you do not have to start paying your student loan back until you graduate, change your enrollment status to less than half time, or leave school. This helps you to initially focus on going to school, and not so much on the debt. This is crucial, because full-time students quite often don’t have the availability to work enough to feed themselves, cover their normal monthly bills, and then of course, pay for their education. By not having to pay back the loan right away, you are able to get through school and enter the workforce with your degree,before taking on any payments. Alternately, if you go with a private loan, many of these loans require that you make payments why you are still at school.

Interest Rates Can Vary Drastically

Interest rates can vary drastically between these types of loans, as federal loans typically have lower interest rates, and they are fixed. For the year 2018, undergraduate degrees through federal programs had a fixed interest rate of 5.05%, with the ability to lower this rate through various programs, such as automatic payment. Contrast that with private student loans, which often have variable interest rates, considered to be a major credit trap, and the interest can run much higher, some as high as 20%! This obviously will increase the amount of money you will need repay for your education.

Federal Loans Can Be Subsidized

Federal loans quite often are subsidized if there is financial need. This typically means that the government pays the interest rate while you are in school. A private student loan is not subsidized. No one pays interest on your loan but you, and even if you do have a grace period during school, that interest continues to build, thereby costing you more money. By having a subsidized loan, you can save yourself quite a bit of money over the longer-term.

Co-signers and Repayment Plans

When using a federal student loan, you won’t need a co-signer. However, a private bank loan will more than likely ask for a co-signer, quite often the parents of a younger student. Beyond that, there are several repayment plans that federal loans offer. One of the most common is to tie your monthly payment to your income level. While some private loans offer payment plans themselves, they typically aren’t nearly as flexible as federal loan programs. You can even go into forbearance, if you are using a federal loan. This allows you to put a hold on payments in times of financial distress. There are no prepayment penalties with the federal loan, while private loans could have them.

Defaulting Means Different Things with These Loans

The last thing you want to do is to fall on a loan. However, you should realize that the consequences are quite different between a federal student loan and a private student loan. A private student loan is considered to be in default after 120 days of nonpayment.Federal student loans are not considered to be in default until 270 days of nonpayment.Beyond that, private lenders will seek payment from any co-signers on the loan when payments are late. They are not required to wait until the borrower is in default.Because federal loans are not co-signed, you won’t have to worry about hurting relationships, if something goes wrong.

In addition, lenders can add massive amounts of collection charges to the amount that you owe. There are stories of debts increasing as much as 40% because of this. While the federal government is able to garnish your wages without getting a court order, the amount that they can take is limited to 15% of your disposable income. Contrast that with private lenders who have the ability to take 25% of your income after getting a court order.

The Choice is Obvious

Quite frankly, 99% of the people that are reading this article should be thinking about federal student loans. Sometimes private loans are used to subsidize education when the amount that the federal government allows you to borrow has run its course, which is quite often seen in higher end institutions. For most of us though, federal student loans are clearly the superior choice.

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