The Difference Between Federal And Private Student Loans
Student loans – two words that can symbolize a godsend or a financial nightmare for many Americans.
It’s no secret student loan debt in the US has grown out of control in the last decade. Student loans have become the largest domestic debt category, reaching an astronomical $1.6 trillion. This number alone is larger than credit card debt at $1.03 trillion, as well as the amount taken for auto loans at $1.13 trillion.
What many don’t know about student loans is that there are two different types: federal student loans and private student loans.
Federal Student Loan
Federal student loans are offered by the U.S. Department of Education. They tend to have lower interest rates and more flexible repayment plans than private loans. It’s required to complete and submit the Free Application for Federal Student Aid (FAFSA) in order to qualify for a federal loan.
Private Student Loan
Private student loans can come from many sources, including banks, credit unions, or other private lenders. If you opt for a private loan, you can use the loan proceeds toward whichever expenses you wish, including tuition, room and board, books, living expenses, or even transportation.
Last year, $1.4 trillion of the $1.6 trillion in outstanding U.S. student loan debt was accounted for in federal loans. The remaining $119 billion was lent by banks, credit unions or other financial institutions, which are commonly referred to as private student loans or alternative student loans.
Regardless of loan type, there are both pros and cons to taking out a student loan. Before making any financial decision, it’s important to educate yourself and understand if you’re making the right one for you and your financial wellbeing.
Advantages of Private Student Loans
Private student loans are less common than federal loans, but may better suit your personal financial situation. Here are some key things to consider:
Credit score and interest rates: Private loans have fixed interest rates determined by the government. These interest rates will take into account whether or not you have good credit. If you do have a high credit score, you can be offered interest rates as low as 3 percent. This can be particularly appealing for adults who have already built strong credit and plan on returning to school to acquire a Graduate or Master’s degree.
Higher borrowing limits. You’re able to borrow up to 100% of your cost of attendance with private student loans. Although this is not advised, if you plan on attending a more expensive, private school, a private student loan may be able to cover all of your costs upfront in comparison to the limitations that you may experience with a federal loan. If approved by your bank, you could potentially pay for all of your college expenses with your one private student loan.
Statute of limitations. This is essentially the time period a lender or creditor has to file a lawsuit against you, the borrower, if you aren’t paying off your debt. It’s rarely recommended to default on your student loans, but should the worst case scenario occur, it can be comforting to know that there is a statute of limitations when you default on a private loan. These limitations differ from state to state, but after a given period of time lenders have very few options to collect from you.
Advantages of Federal Student Loans
Since most people elect to use federal student loans for their college education, it’s important to examine and understand what they’re able to offer:
Credit score and iInterest rates. Although there are some private loans that offer fixed rates, it’s uncommon. As interest rates rise over time, so does your variable interest rate. It’s important to note that interest on your private loans start to accrue from day one.
On the contrary, some federal loans offer an interest subsidy which pays for the cost of your interest while you’re attending school. The interest you pay on your federal loan is the same for everyone and will not be affected by changes in the economy or your credit score.
Income-driven repayment options. If you’re struggling to make your student loan payments, federal loans will cap the amount you owe to a small percentage of your monthly income.
If eligible, you can apply for federal forgiveness programs such as Public Service Loan Forgiveness, a federal program designed to forgive student loan debt for employees of certain public and nonprofit jobs.
Cosigner. With federal loans, you probably don’t need a cosigner, regardless of your credit score. With private loans, even if you have great credit, chances are your loan will need to be cosigned. Over ninety percent of private student loans require a cosigner who is legally responsible for your debt if you’re unable to repay it. The consequences your cosigner can suffer if you don’t pay off your loan can be detrimental to their own financial health. It can affect their credit score and debt collectors are able to go after them for repayment.
Private Debt Never… Goes Away. As mentioned above, it’s unlikely that your federal loan will need to be cosigned. If you were to pass away, technically your debt would die with you. Unfortunately, the debt you owe on a private loan doesn’t disappear. If your private debt wasn’t cosigned, then lenders can even go as far as reducing the value of the inheritance you leave behind.
How to Pay off Your Student Debt
If you do decide to take out a student loan, as many Americans do, the key to staying on top of your debt is to prioritize paying them off above anything else. It can be overwhelming to graduate from college already owing thousands of dollars, so creating a budget for yourself and eliminating extraneous costs can help you leaps and bounds in the long run.
Pay more than your minimum monthly payment. This may sound impossible, but it’s arguably the most important factor in tackling your student loans. The goal here is to save as much as you can on the interest you owe. The more you pay above the minimum (20% more is recommended), the quicker your debt will be paid off. In theory, if you were to pay off your student debt in 8 years versus 10 years, you would be saving two years worth of interest on your student loans – on average that’s $2,500!
Budgeting. Whether you have debt or not, budgeting is essential in managing your personal finances. Creating a budget for yourself will allow you to assess how much money is coming in and how much money is going out each month. Cut out unnecessary costs like dining out, splurging on fancy coffees, or treating yourself to lunch. Pack a lunch for work, make your coffee at home, and eat out to twice a month instead of twice a week.
As you cut your costs, you will start to notice that you have more money at the end of each month. Use this extra income to pay the 20% we discussed earlier.
Be creative. You don’t need to limit your income to just your salary when it comes to paying off your student loans. Be creative with your time and your resources. Babysit on the weekends, sell furniture or electronics you no longer use, ride your bike when you can to save on gas expenses, or even find a roommate to split your rent… the options are endless!
Pro tip: Many people believe their annual tax refund is “free money”, but it’s not. It’s money you’ve earned and is rightfully yours. Instead of spending your tax refund on an upgraded phone or new wardrobe, use that money to pay off your student loans!
Consider What’s Best for You
It’s important to understand how student loans can help you, and how they can hurt you financially.
When shopping for student loans, evaluate what best suits your own financial situation so you don’t walk away with thousands of dollars in unnecessary debt and interest payments.
If you’re interested in learning more about how you can take control of your financial well being, or how you, as an employer, can help your employees resolve personal financial emergencies download our Webinar: Financial Wellness Programs – do they work? today to learn more.