Which type of student loan is best – federal or private?


Which type of student loan is best — federal or private?


Private student loans should be used only after the student has exhausted eligibility for gift aid (money that does not need to be repaid) and federal student loans.

Federal student loans are usually cheaper, more available, and have better repayment terms and conditions than private student loans. Federal student loans offer income-based repayment and public service loan forgiveness, while most private student loans do not. Federal student loans also offer more flexible repayment options for borrowers who encounter financial difficulty, such as deferments and forbearances.

More than 93% of new education loans are federal, with only 7% private student loans.

Some students do not exhaust eligibility for federal student loans before borrowing private student loans. Based on the 2011-2012 National Postsecondary Student Aid Study (NPSAS), about a quarter (24.9%) of undergraduate private student loan borrowers did not borrow federal education loans. More than half of these students did not file the FAFSA (Free Application for Federal Student Aid). Of those who did borrow federal student loans, 43.2% borrowed less than the effective total maximum.

There are a variety of reasons why students might choose to borrow private student loans instead of or in addition to federal student loans.

  • College cost is an important reason. Students enrolled at colleges costing $30,000 or more are twice as likely to borrow private student loans as students enrolled at colleges costing less than $10,000.
  • The cost of the loans may be another factor. Federal student loans do not require cosigners, while most private student loans do. More than 90% of new private student loans to undergraduate students and more than 75% of new private student loans to graduate students require a creditworthy cosigner. Having a cosigner with an excellent credit score may yield a low interest rate that is competitive with the interest rate on the PLUS Loan. Some private student loan borrowers with variable interest rates may also be planning on paying off the private student loan before interest rates start increasing.
  • The student’s parents may be unwilling or unable to borrow a Parent PLUS Loan. Independent undergraduate students are ineligible for the Parent PLUS Loan, as are students who are not maintaining satisfactory academic progress and students who are enrolled on a less than half-time status.
  • Students who have exhausted the Direct Subsidized and Unsubsidized Loan limits are more likely to borrow private student loans.
  • If a dependent undergraduate student’s parents are going through a messy divorce, they may be unwilling to complete the FAFSA (Free Application for Federal Student Aid). The FAFSA is a prerequisite for most federal student loans, including Perkins Loans, Direct Subsidized Loans, Direct Unsubsidized Loans, and PLUS Loans.

If a student is going to get a private student loan, he or she should shop around. Most private student loans do not have up-front pricing, so the only way to determine the cost is to apply for the loan. Interest rates and fees are based on the credit scores of the borrower and cosigner. The lowest advertised rate is not offered to all borrowers, so the actual rate for an individual borrower may be much higher and vary considerably from lender to lender. Compare private student loan options at PrivateStudentLoans.com.

There is little harm in applying for several private student loans. Applying for a private student loan does not commit the borrower to accept the loan. Applying for several private student loans will also not have a significant impact on the borrower’s credit score, since the credit bureaus now recognize shopping-around behavior in looking for the best terms and conditions on a loan.