Financial Aid: Federal Student Loans vs. Private Loans

Posted in #LetsBFRANK: The College Admissions Blog on July 7, 2020

This post was written by Marie Gendron

Sometimes, grants, scholarships, and need-based aid aren’t enough to cover the full cost of attending college. Whether you currently have student loans or are considering applying for them, understanding the difference between federal and private student loans could save you thousands of dollars.

Understand the difference between federal student loans and private student loans

The basic difference between the two types of loans is that federal student loans are offered by the government, while private loans are offered by a private-sector lender such as a bank. But both federal loans and private loans are legal agreements. Both types of loans must be repaid, plus interest, whether or not you graduate from college. So, be sure you understand what you’re signing and ask questions if you don’t.

Here are 5 things to keep in mind when deciding whether to take out federal or private student loans to help pay for college.

1. Federal student loans are almost always your best borrowing option.

The chief benefit to federal student loans is that they typically offer low, fixed interest rates. Some federal loans are also subsidized, meaning that interest on the loan does not start accruing until after you graduate. For unsubsidized loans and private loans, interest starts accruing as soon as the loan is taken out.

Additional benefits of federal student loans include:

You won’t have to undergo a credit check.
You will have more flexible repayment plans, such as an income-based repayment plan for people who cannot afford high monthly payments.
You can change your repayment plan even after you’ve taken out the loan.
You may qualify for one of a number of loan forgiveness programs offered by the federal government, such as programs for those who go into teaching or other public sector roles.

“We always want students to maximize their federal student loans first,” says Shani Wilkerson, BFIT’s Director of Financial Aid. “I always tell students, you’re repaying loans for 10 years and life happens in a decade. You’re done with school, you might relocate, change jobs, start a family, be out of work, or have a medical issue. You want to have that flexibility and some of the loan options that are out there from private sources don’t have those benefits.”

2. Complete your FAFSA—every year.

To apply for federal student loans, students must complete the Free Application for Federal Student Aid (FAFSA). The FAFSA submission period is from October to June each year, though you can still fill out an application after the priority deadline. In addition to federal loans, the FAFSA is also used to determine your eligibility for aid programs like grants, work-study, and some college-based scholarships. There’s no cost to apply.

“Even if parents don’t think they’ll qualify for aid, I’m always pushing them in the direction of the FAFSA,” Wilkerson says. “Even if the student isn’t eligible for a Pell Grant [which does not need to be repaid], they might be eligible for a subsidized loan that won’t accrue interest while they are in school. Over time, that can make a huge financial difference.”

3. Private student loans can be a good option—after you’ve explored scholarships, grants, and federal loans.

Private student loans are offered by banks, credit unions, state loan programs, and non-federal institutions. There are two main benefits to these loans:

You may qualify for a higher borrowing limit if you have a co-signer with good credit. Federal student loans are capped each year (currently $5,500 for a student’s first year in school). But private student loans can be taken out for any amount up to the full cost of attending college.
You may qualify for a low interest rate if you have excellent credit.

“Coming up with a strategy for paying for college can be daunting, but it does not have to be,” says Christine Roberts, Head of Student Lending, Citizens Bank. “I always tell students and their parents that the most important thing to do is to make sure you understand all of your options…..I would also suggest three important tips: know exactly what your school will cost, pick up as much free money as possible, and determine your best options to fill the gap. When it comes to filling the gap, look at different lenders and what they could provide.”

Ultimately, the repayment terms are just as important as the interest rate. Be sure you do your homework before you sign. Some key points to understand:

Some private student loans offer variable interest rates, which means your payment increase if the federal interest rate increases (as it has since 2015).
Private student loans are never subsidized, so interest starts accruing as soon as you take out the loan.
Private student loans offer less flexibility in terms of repayment. You cannot get these loans forgiven and an income-driven repayment plan may be an option, but it’s not a given from the beginning of repayment. Private loans would require you to apply for such a benefit and supply supporting documentation.
Some private student loans require you to start making payments while you are still in school.

4. Private student loans are not the same as personal loans.

Private student loans typically have lower interest rates than personal loans or lines of credit. Private student loans are solely for education and are usually sent directly to your school’s financial aid office. So, they cannot be used to cover expenses like books, transportation, or off-campus housing. Personal loan funds are deposited directly into the borrower’s bank account and can be used to buy a car, pay rent, and a wide variety of other expenses.

Wilkerson says that if you’re considering borrowing, it’s smart to plan for the worst-case scenario. “When it comes time to repay, if you miss one private loan payment then you’ll have to repay the full amount of the loan the next month,” she says. “The consequences of that and how it’s going to affect your credit is a lot different than the federal loans, which will offer loan rehabilitation and won’t look to garnish your wages right away.”

5. Your college’s Financial Aid Office can help you figure out your loan options—and more.

If you don’t understand your financial aid package or want some help figuring out the best ways to pay for college, your first stop should be your college’s Financial Aid office. Financial Aid counselors have a wealth of knowledge and they are eager to help students and their families ease their financial anxiety.

Wilkerson says she spends about three-quarters of her time helping students and families sort through financial aid issues. She often counsels students to help them understand their loan options. But there may also be alternatives to loans. For example, if a student owes a relatively small balance, say $800, she might help them set up a payment plan or file a financial aid appeal that could result in a bigger scholarship (which does not need to be paid back).

The overarching goal of every Financial Aid office, Wilkerson says, is not to just help students pay for college but to help them gain financial literacy skills that will help them succeed throughout their lives.

“Talking about money, or lack thereof, nobody really wants to have those conversations,” she says. “So, we try to avail ourselves as much as possible not just to enrolling students, but also to current students.”

In addition to one-on-one meetings, Wilkerson’s office hosts student workshops on topics like budgeting, credit scores, how to balance expenses and income, the difference between subsidized and unsubsidized loans, and more. It also distributes information about how students can get discounts on transportation, books, and many other items.

“Anything that’s going to help them financially or otherwise to be successful is our job,” Wilkerson says.

At Benjamin Franklin Institute of Technology (BFIT), we are committed to creating opportunities for any student who wants to work toward a better future. And we promise to always provide the facts you need to make an informed decision about your education.