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How Do Federal Loans and Private Loans Compare?

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Though federal and private student loans work similarly and fund the same thing — your college education — they differ in some key ways. And since you’ll likely be repaying this debt for 10 years or more, seemingly small variations can cost you big time. 


Check out how federal and private student loans compare and which one could be best for you. 

Federal vs. Private Student Loans: Overview

Federal student loans are funded by the U.S. government, and there are several types available. In contrast, private student loans are funded by private institutions such as banks, credit unions, and online lenders.


The terms are of federal loans are set by law and include benefits you typically don’t see in private loans, such as flexible repayment and lower interest rates. It is also easier to qualify for federal loans for most borrowers, but especially for young people. 

Eligibility and Application Process

Undergraduates, grad students, and parents may all be eligible for both federal and private loans. However, a major difference between the two is the credit required to borrow. 


Though some types of federal loans require you to pass a credit check, most do not. This can be a huge plus for borrowers, especially those who are younger and haven’t had time to build strong credit yet. Reputable private lenders, on the other hand, do require you to pass a credit check to borrow. However, both types of loans typically allow you to add a cosigner to your application, which can help you qualify if your credit alone isn’t enough. 


The application process also varies significantly. To apply for a federal student loan, you’ll need to submit the FAFSA annually. Though this application can be quite involved — and you’ll likely need to include your parents’ financial info — you just submit one application and you’ll receive a letter notifying you of which loans and financial aid you qualify for. 


To apply for private loans, you’ll need to submit an application with each individual lender. While you can typically comparison shop and see your estimated rates and terms, you’ll need to review this on each lender’s website before submitting a formal application to the companies that offer the most favorable terms. This can be more time-consuming than the federal application process.

Interest Rates and Fees

Interest rates on federal student loans are set by law, and because of this, your credit won’t affect the interest you pay. Federal interest rates are also fixed, which means they won’t change over the life of your loan. Interest rates for the 2020-21 school year range from 2.75 to 5.30 percent, depending on the type of loan. 


There are even some types of federal loans that will pay your interest for you during certain periods. Though you must prove financial need to qualify, this could save you thousands over the life of your loan. 


Private student loans, however, set your interest rate based on your credit and other factors. This means there will be more variation in the rates you see, and each lender will offer you a different rate. The 2020 rates usually range from about 2-3 percent up to 13 percent or more. Borrowers (or cosigners) with excellent credit may find better rates with private loans, but many will find that federal loans are cheaper. 


Private interest rates can also be fixed or variable, which means that your rate can change several times a year based on certain indicators. You could qualify for lower interest if you opt for a variable rate, but you take a risk doing so since rates can increase without much warning. However, if you plan to pay the loan off quickly (think five years or less), this may be a risk worth taking. 


Variable rates can be a good thing if rates go down, but if they rise you may end up paying more than you bargained for.  


Pay attention to origination fees as well; these fees are charged when the loan is distributed. Federal loans in 2020 come with a fee of 1.059 or 4.236 percent, depending on the type of loan you borrow. Some private lenders charge similar fees, but many don’t — making this fee largely avoidable if you opt for private loans. 

Repayment Plans

One of the biggest perks of federal loans is the flexible repayment plans on offer. The standard plans give you 10 years to repay your debt. You can spread payments evenly over that time or have them start small and gradually increase. 


However, if you need more time or lower monthly payments, that’s available, too. There are several income-driven plans that you may qualify for. Though each works a little differently, most will extend your repayment to 20 or 25 years and set your payments at 10 to 20 percent of your income. After you’ve completed the terms of repayment, your remaining debt can be forgiven. 


Though income-driven plans sound like a great deal, note that you’ll likely pay more interest using them since you stretch repayment out over two decades or more. However, if you’re struggling to afford your payments they can be a welcome lifeline. 


Repayment plans for private student loans vary a lot more and depend on the lender you choose. Standard repayment is usually 10 years, but you can often opt for plans as short as five years or as long as 15 or 20 years. And while you can usually pause your payments temporarily if you run into financial trouble during repayment, you’ll be hard-pressed to find a private lender who can match the income-driven options offered on federal loans. 

Federal vs. Private Student Loans: Which is Best? 

Whether a federal or private loan is best depends on your exact situation. Borrowers with excellent credit may find better interest rates with a private lender, but you do miss out on federal protections such as flexible repayment or even loan forgiveness. 


However, private loans often offer higher borrowing limits than federal options. This means that if federal student loans don’t cover all your education costs, private debt can fill in the gap. For most borrowers, it usually makes sense to max out their federal loans before pursuing private lenders. Compare all your options and see which makes the most sense for you.

5 Key Takeaways 

  • Most federal loans are easier to qualify for and do not require a credit check. 
  • For many borrowers, federal loans can offer lower interest rates. Well-qualified borrowers may find better rates with private lenders, though. 
  • Federal student loans come with origination fees, but many private loans do not.
  • Federal student loans generally come with more protections for borrowers who are struggling to repay. 
  • Private student loans usually have higher borrowing limits, making them a useful option to cover education costs that federal loans don’t. 

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