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Comparing Federal to Private Loans

One of the most confusing aspects of taking out a student loan is determining what the terms are. How much you are borrowing, when you have to start paying it back, how much interest you will owe, and how long you will have to make the payments?

These questions are particularly vexing because of the variety of types of student loans — and student lenders. There is the subsidized Stafford Loan and the unsubsidized Stafford Loan. There are lenders like Sallie Mae and Citigroup and then there’s your bank down the street.

You have probably figured out by now that not all student loans are created equal, but how do you determine which loan is best for you?

One of easiest ways to level the playing field is by dividing student loans into two teams: Federal Student Loans and Private Student Loans. Here’s an explanation of these two categories, along with the benefits and disadvantages of each one.

Federal Student Loans

The federal government first began its student loan program in 1958 by capitalizing loans directly from the U.S. Treasury. In 1965, it switched its focus to guaranteeing student loans through the Federal Family Education Loan (FFEL) program. Today, federal student loans are offered through private lenders, such as Sallie Mae, which are then sold to investors.




Benefits of Federal Loans

  • No need for a cosigner — the government guarantees your loan
  • Interest rates are set by Congress, and are typically much lower than on private student loans
  • Your financial need determines whether or not you are eligible to take out a federal student loan — not your credit history
  • Repayment terms are more flexible and more varied
  • More flexibility in the event of a personal financial crisis, enabling you to put loans on deferment or in forbearance

Disadvantages of Federal Student Loans

  • The amount you can borrow is set by Congress — so the loan may not cover all your costs
  • If you default on your loan, the federal government has wide reaching power to get its money back, including garnishing your wages and your federal tax returns
  • Federal student loans are not bankruptable (even if you declare Chapter 7 or Chapter 13 bankruptcy, your federal student loans will not be wiped out)

Private Student Loans

Private student loans are a form of unsecured personal loan. Think of them like a credit card, but with a one-time spending limit and slightly better interest rates. Unlike federal student loans, which are guaranteed by the government, private student loans are not guaranteed.

Benefits of Private Student Loans

  • The total amount of a private student loans is not limited — you can take out as much as you need to cover your costs
  • They are not need-based, so even if your parents make a good income, you are not barred from qualifying

Disadvantages of Private Student Loans

  • Eligibility depends on your credit score — in this current financial climate, you will probably need at least a 700 FICO score to qualify
  • Most lenders require you to have a cosigner (who also has a high FICO score)
  • Higher interest rates than federal student loans
  • More restrictive repayment terms than federal student loans
  • Decreasing number of lenders making private student loans, in light of the ongoing financial crisis

Hopefully that clears up some of the confusion about federal vs. private student loans, but there is one other thing to keep in mind. In February 2009, President Obama announced that he wants to re-nationalize federal student loans. Instead of just guaranteeing the loans, his plan calls for the Department of Education to become the actual lender as well.

 

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