What are the differences between federal, college and private loans?


I am starting at college soon. My parents and I are still trying to determine if we should borrow money for college. We’re confused by the differences between federal, college and private loans. Any suggestions as to which type of loan is best?


It is best to borrow as little as possible for college. Budget before you borrow. Try to borrow only what you absolutely need. Do not treat loan limits as targets. Every dollar you borrow will cost about two dollars by the time you repay the debt. Before you spend student loan money on anything, ask yourself if you’d still buy it at twice the price. Live like a student while you are in school, so you don’t have to live like a student after you graduate.

But, if you must borrow to pay for college, borrow smart.

Do not assume that just because a loan is labeled as a need-based loan that it is necessarily lower cost than other options. Need-based loans are often subsidized, which yields the equivalent of a zero percent interest rate while the student is in school. But, some institutional need-based loans offered by the college as part of the financial aid package may have a higher interest rate than some private student loans and may offer less flexible repayment terms than the federal student loans.

The primary differences between different types of education loans, besides the source of funding, are in the cost, eligibility criteria, loan limits and repayment terms. There may also be differences in who is obligated to repay – the student and/or the parent – and in cosigner and collateral requirements.

The comparison of loan options chart provides a detailed list of the most important differences between federal student and parent loans and private student loans.

For many families, the cost of the loan matters most. The cost will depend on the interest rates and fees of the loan, as well as any loan discounts. Watch out for several pitfalls that can affect the cost of the loans and make it difficult to compare borrowing options:

  • Fixed vs. variable interest rates. Some loans have a fixed interest rate, which does not change over the life of the loan. Other loans have a variable interest rate, which may change periodically, sometimes as frequently as monthly. While a variable interest rate may nominally seem lower than a fixed rate because of the current low interest rate environment, these interest rates have nowhere to go but up. A variable interest rate may ultimately cost much more than a fixed rate. Assuming a 10-year repayment term, the equivalent fixed rate may be as much as 4 percentage points higher than the initial variable rate.
  • Loan fees. Loan fees are up-front charges, usually deducted from the loan disbursement, which can increase the cost of the loan. Some loans have fees, others do not. This can affect comparisons of interest rates. Assuming a 10-year repayment term, 4 percent in fees is about the equivalent of a 1 percentage point increase in the interest rate. The annual percentage rate (APR) is intended to bundle in the cost of the fees with the interest rate. But, APRs are imperfect tools for comparing loan costs. For example, increasing the repayment term of a loan will generally reduce the APR by amortizing the fees over a longer period of time. Lenders may also differ in how they count the time between loan disbursement and the start of repayment when calculating the APR.
  • Repayment term. Increasing the length of the repayment term will reduce the monthly loan payment amount and APR, but will also increase the total interest paid over the life of the loan. Using different repayment terms when comparing two different loans can yield a misleading comparison, as discussed in compare loan costs carefully, since the loan with the longer repayment term may have a lower monthly payment despite a higher interest rate. Treat the two loans as though they have the same repayment term when comparing the cost of different loans.

Generally, students should borrow federal first, as federal student loans are cheaper, more available and have better repayment terms. Parent loans and private student loans may be options when a student has exhausted the federal student loan limits. But, needing to borrow from the Parent PLUS Loan program or private student loans may be a sign that the student is over-borrowing. Total student loan debt at graduation should be less than the student’s expected annual starting salary, and, ideally, a lot less.