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Blog » Money Tips » Private vs. Federal Loans: Which is the Better Choice for Your College Financing?

Private vs. Federal Loans: Which is the Better Choice for Your College Financing?

Posted on August 18th, 2023
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Figuring out the best ways to manage your college expenses can be overwhelming!

As you brace up for your college days, you must already have applied for your scholarships and grants. So, what’s next? You must be doing the math to find out your deficit before applying for a student loan.

Well, you have two types of college financing options: federal loans and private loans. While federal loans are government-sanctioned and come with an upper cap, private loans are granted by banks and don’t come with any such limitation. Regardless of the type of loan you choose, you need to repay the amount along with the interest, whether you complete your college education or not. Unlike grants and scholarships, student loans aren’t free money. So, it’s imperative to be careful about your financial planning and how you approach loans.

Ideally, college students should try to qualify for federal loans at the outset. Next, they need to apply for private loans to make up for the deficit. Let’s explore these two prime funding options for college education. We have comprehensively discussed the benefits and drawbacks of each type of loan.

What are federal student loans?

Federal student loans are provided through the Department of Education in the US. These loans are highly sought after and account for as much as 92% of student debt. The interest rate remains the same for all borrowers.

From low-interest rates to easy approval, federal student loans have several benefits over private loans. These loans also offer more flexibility, making the repayment process stress-free. When you look out for education loans for college, try to qualify for as many federal student loans as possible.

One can qualify for different types of federal student loans.

Direct Subsidized Loans: If you are facing financial hurdles to fund your college education, apply for direct subsidized loans. The government will cover the interest while you are studying and also during the grace period and deferment.

Direct Unsubsidized Loans: These are the standard loans where the government doesn’t pay your interest. Both graduate and undergraduate students can apply for these loans, regardless of their financial condition.

Direct PLUS Loans: Direct PLUS loans are available to both parents and students. Undergraduate students can apply for direct PLUS loans. This is the only type of federal loan that doesn’t specify an upper cap on borrowing.

However, federal loans are available for funding college education only at eligible institutions.

What are the benefits of federal student loans?

Let’s check why federal loans are highly sought after and what makes them a better choice compared to private loans.

Lower interest rates

Usually, federal student loans are cheaper compared to private loans. As an undergraduate student, you might not have a stable source of income. Neither do students have a reliable credit history. In these conditions, it’s wise to apply for federal loans rather than approaching private lenders.

No credit requirements

Most students get federal loans easily sanctioned since the government doesn’t check their credit scores. As a student, it’s easy to qualify for these loans if you apply with a co-signer. Usually, parents need to apply along with the applicant to get the loan sanctioned.

Only for Direct PLUS Loans, the lenders would check the credit report of your parents to detect whether they have any negative items, such as bankruptcy. So, you don’t need to build your credit history to qualify for federal loans.

Easy and stress-free repayment

With federal student loans to fund your college education, you can access an income-driven repayment plan. This strategy, devised by the Department of Education, requires students to pay just 10% of their discretionary income. During college, most students engage in side hustles and part-time jobs to ease up their finances. In case you are struggling with your bills, an income-driven repayment plan would take your pressure off.

Provision of loan forgiveness

One of the key perks of applying for a federal student loan is the availability of different loan forgiveness programs. In case you fulfill the criteria, you can have student loan debt worth thousands of dollars forgiven. Some of these programs include Teacher Loan Forgiveness and Public Service Loan Forgiveness (PSLF)

In case you work full-time under a qualifying employer and make 120 monthly payments or repay the debt consistently for the first ten years, you can get the remaining amount forgiven.

Automatic discharge

In case of any unfortunate incident leading to disability, the loan balance would be discharged automatically. This discharge is also applicable in case of the death of the student. If the parent had taken a PLUS loan, it would also be applicable in case of their death.

What are the drawbacks of federal student loans?

Federal student loans, although popular, are not free from pitfalls. Before you apply for one of these loans, it pays to remain informed about these drawbacks.

Upper cap on loan sanctioning

The key drawback of federal student loans is the upper capping on the sanctioned amount. This capping depends on whether you are an independent or a dependent student. Besides, the amount differs between undergraduate and graduate levels of study.

Undergraduate students can borrow $12,500 per year and a maximum of $57,500 over the course duration. For graduate students, the annual and overall limits are $20,500 and $138,500. This capping makes students dependent on private loans, which turn out to be expensive.

Upfront fees

Students must pay an upfront fee of 1.057% when they apply for federal loans. Although this is a small percentage, it comes to a sizable amount depending on the loan size. For PLUS loans, this charge is relatively high, around 4.228%. These charges are usually not applicable to private student loans.

No choice of servicer

The Department of Education, while sanctioning federal loans to college students, assigns a loan servicer to the borrower. You don’t get to choose who your servicer would be. In case you find it challenging to clear your repayments, you have the option of getting the loans consolidated with a different servicer. However, this can affect the student’s access to some protections and benefits.

Debt collectors can bypass court

In case of non-payment, private loan lenders count on the decision of the court. Their power is limited by the state. However, failure to repay a federal loan can lead to the garnishing of your wages. Federal debt collectors have the power to bypass courts and seize tax refunds directly.

What are private student loans?

Private lenders such as banks, NBFCs, and credit unions offer private student loans. Qualifying for these loans requires a decent credit score. Therefore, the lender would sanction the loan only if your co-signer has a healthy credit report. Your parent’s creditworthiness goes a long way in getting the loan sanctioned. Students find it challenging to qualify for private loans independently.

Usually, students count on private lenders when federal loans fall inadequate to fulfill their requirements. Usually, the repayment term ranges from five to 20 years. The interest rate for private student loans can be fixed or variable. Usually, they are higher than the rate of federal loans.

What are the benefits of private student loans?

Private student loans have some strategic advantages over federal loans, although they prove to be expensive.

No upper capping

Unlike federal loans, private student loans don’t come with stringent clauses on how much you can borrow. If you can demonstrate your creditworthiness, you can even borrow the entire cost of attendance. So, if you find that your sanctioned amount through a federal loan is falling short of covering your college expenses, you can rely on private lenders.

However, refrain from over-borrowing since you need to repay the entire amount along with high interest. Calculate your deficit after factoring in your parental income, job earnings, scholarships and grants, and federal loan, and borrow accordingly.

Chances of low interest

Well, if your parents have an excellent credit score, you can qualify for a low-interest student loan from a private lender. Although rare, this rate can be even a few percentage points lower than that of your federal loan.

No upfront fees

Private lenders usually do not charge an upfront fee while sanctioning student loans. So, college students can save a significant amount while applying for these loans.

What are the drawbacks of private student loans?

The lack of loan forgiveness programs and high-interest rates are the key downsides of private student loans.

No protection

Unlike federal student loans, private loans for education don’t offer any scope of forgiveness. Besides, you don’t enjoy the privilege of an income-driven repayment plan. This often leads to financial stress when it comes to repayment. There’s no permanent solution to lower your monthly obligation unless you repay this debt.

High-interest rates

Private lenders sanction education loans only after a credit check. This implies that banks will charge high-interest rates if you have low credit or no credit record. This can make private education loans expensive for most students.

Immediate consequences on default

In the case of federal loans, you get a long window of 270 days after non-payment before it is considered as default. Federal borrowers get a long time to restore their image. However, the consequences of defaulting on a student loan are more immediate and harsh for private loan borrowers. You get just 30 days to pay the installments. Any further delay can potentially tarnish your credit score.

Which type of student loan should you apply for?

For college students, federal loans are easily available and affordable compared to private loans. You can enjoy the benefits like fixed interest rates, loan forgiveness, flexible repayment programs, and subsidies. Private loans don’t come with such perks.

However, students also need to bank on private loans in certain situations. For instance, if you have already hit the upper limit of borrowing federal student loans, a private loan may be necessary to help you ease your finances.

Your financial stature and your cosigner’s credit score largely determine whether a private loan would be affordable to you. If you have a decent income as a student or your credit score looks exceptionally good, applying for a private loan makes sense. However, if you want to take advantage of income-driven repayment schemes or extensive deferment, go for a federal student loan.

Your college years mark the beginning of your financial journey since you would be independently handling funds. So, it’s wise to be strategic with your borrowings. Forward-thinking individuals strive to be debt-free at the earliest and take a leap toward financial freedom. 

So, try to maximize your scholarships and grants, and then engage yourself in a productive side hustle or job. This will help you stream a monthly income while you continue your undergraduate studies. Start paying off your student loan, whether a federal or private one, aggressively as soon as possible. This calculated stance to responsible finance handling will put you on track to financial freedom soon after you graduate.

Now that you know which type of loan to go for and how much to borrow, you will be a better fund manager while financing your education. 


What is the current rate of federal student loans?

Currently, the interest rate of Direct Subsidized Loans and Direct Unsubsidized Loans is 4.99%. Direct Unsubsidized Loans come at a 6.54% interest rate, while Direct PLUS loans require graduates and parents to pay 7.54%.

For how many years can I take a federal student loan?

Although most students try to clear federal loans in the first ten years, the Extended Repayment Plan enables borrowers to make repayments over 25 years. This helps students that require more time to establish themselves financially. However, extending the loan tenure also leads to higher interest accumulation. You would be paying a lot more over time.

What can happen if I never pay off my student loans?

Not paying your student loans would be an act of financial irresponsibility. You may lose out on your chances of receiving any kind of financial privilege from banks in the future. Defaulting on a private loan would have immediate consequences. Once these defaults start affecting your credit score, you will find it challenging to qualify for any other loan. Whether you decide to get a home loan or a personal loan, your poor credit score would be a hurdle.

What are existing private student loan interest rates?

If you decide to finance your higher education in the US through a private lender, you can choose between fixed and variable-interest-rate loans. Fixed-interest loans come at rates between 5.99% to 13.78%. On the other hand, variable interest loan rates vary between 5.61% and 13.27%.

How much do students have to repay on their loans?

For federal student loans, the average monthly repayment is $278 for bachelor’s degree students. For master’s degree holders, this amount is as high as $572. However, many students try to repay a higher amount so that they can close their loans faster.

Deanna Ritchie

Deanna Ritchie

Deanna Ritchie is a managing editor at Due. She has a degree in English Literature. She has written 2000+ articles on getting out of debt and mastering your finances. She has edited over 60,000 articles in her life. She has a passion for helping writers inspire others through their words. Deanna has also been an editor at Entrepreneur Magazine and ReadWrite.

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