Figuring out college-related finances before starting the school year can be a complicated and frustrating process. You'll hear about federal loans, receive advertisements for private loans and wonder how you'll make the right decision about how much to borrow and from where.
A good first step is to learn about the differences between federal and private student loans, including which option might be best for you as an undergrad, a graduate student or even as a parent.
What Are Federal Student Loans?
Federal student loans are issued by the U.S. Department of Education and are available to eligible students who attend a variety of schools, from four-year institutions to career-focused trade schools. Federal loans make up 92.11% of the $1.73 trillion in student loan debt in the U.S. in 2021, according to MeasureOne's student loan report.
The first step in the federal student loan process is to submit a Free Application for Federal Student Aid form. The data in the FAFSA -- which includes income and asset information from your parents if you're a dependent -- will give the school the information it needs to determine the aid you can receive.
The most common federal student loans are direct subsidized and direct unsubsidized loans for undergraduates, also known as Stafford loans. Unlike loans from banks, credit unions or other lenders, there are no credit checks needed for either subsidized or unsubsidized loans, and the disbursement fees are low.
Direct subsidized loans help undergraduate students based on financial need, and the amount is determined by the school. These loans have the lowest interest rates, and overall costs are less because the federal government covers the interest during and just after college.
Direct unsubsidized loans are available to undergraduate and graduate students, also at an amount set by the school, with no requirement to show financial need. Interest accrues on these loans immediately, although you don't have to begin making payments until at least six months after your studies end. Unsubsidized loans also have higher interest rates than subsidized loans.
The maximum amount you can borrow as an undergrad for subsidized and unsubsidized loans depends on what year of school you are in -- as you advance in college, you'll have the ability to borrow more each year -- and whether you're a dependent or not. The maximum amount for these loans ranges from $5,500 to $12,500 per year.
Direct PLUS Loans are loans that students can use to supplement their Stafford loans. These loans are for graduate or professional students (Grad PLUS) or parents of dependent undergraduates ( Parent PLUS). The maximum PLUS loan amount you can receive is the cost of attendance -- determined by the school -- minus any other financial aid received. The interest rates are higher than the subsidized and unsubsidized loan options, they have a higher disbursement fee fee and a credit check is required.
[Read: Best Student Credit Cards.]
What Are Private Student Loans?
Private student loans are issued to students and/or parents by banks, credit unions and other lenders to cover college-related expenses. Loans can pay for anything from technical training to an undergraduate degree to professional school. Some lenders have specialized loans for things like medical school or law school, or targeted groups of borrowers like international students. They are much less common than federal loans, making up 7.89% of the total student loan market in 2021, according to the MeasureOne report.
Students who have maxed out their federal student loans might find that they still don't have enough to cover the cost of college. That's where a private loan could fill a financial gap.
Private student loans offer fixed and variable interest rates. The lender will conduct a credit check, and because most college students don't have enough of a credit record to take out a large loan, a parent will likely need to be a co-signer.
Private loans typically range from five- to 20-year terms. Variable rates often are lower than fixed and are a good option if you can pay off the loan before interest rates go up too much, says financial aid expert Mark Kantrowitz. If you're going to pay off the loan over the full term, the fixed rate is likely best, he says, adding that you could obtain a lower rate with a shorter repayment term.
[Read: Best Private Student Loans.]
The Differences Between Federal and Private Student Loans
There are several differences between private and federal student loans, including the amount you can borrow, the application process, and the ability to get forbearance and potential loan forgiveness.
The federal government limits the amount you can borrow with its Direct Loans, ranging from a maximum of $5,500 for some undergrads to $20,500 for graduate students in an academic year. There also are aggregate limits -- independent undergrads can borrow as much as $57,500, while dependents can borrow no more than $31,000. Graduate and professional students can borrow up to $138,500, including all federal undergraduate loans.
PLUS loans don't have a cap; they're only limited by the cost of attendance as determined by the school, minus any other financial aid you're receiving.
Private student loan limits will vary by lender, but they are often more flexible than federal Direct Loans. Many lenders have no maximum, and the ones that do have high caps like $50,000 a year or $500,000 total. If you have maxed out your federal loan amount, private loans could be the bridge you need to pay for school.
Interest Rates and Accrual
Federal loan interest rates are set July 1 each year for all borrowers, are fixed rates for the life of the loan , and are often lower than those for private student loans. The undergraduate rate for 2021-22, for example, is 3.73%.
"It is a really good deal," Kantrowitz says. "There are private loans that offer fixed rates that are kind of in the same ballpark as federal Stafford loans. But most borrowers are not going to qualify for those rates."
Private student loan interest rates will vary, often depending on how strong a credit history an applicant -- and potentially a co-signer -- has. Rates can be variable or fixed, but are often higher than federal student loan rates and could reach double digits.
Interest accrues for most loans during college, whether federal or private, except for undergrad subsidized federal loans.
Anyone applying for a federal loan needs to fill out a FAFSA first. Undergrads applying for federal student loans won't need a credit check to qualify, but people who pursue PLUS loans will have their credit history examined.
It's likely quicker to get approval for a private loan -- you can apply online and get preapproval in just a few minutes because of automated credit underwriting, Kantrowitz says. "Usually, if you get this preapproval, you're going to get final approval." The student will need to undergo a credit check to get a private loan and likely will need a co-signer.
When co-signing, a person -- usually a parent -- takes on the loan as their own, which can affect their credit record until the loan is paid off. "Co-signing is not like giving a reference -- you're actually a borrower on that loan," Kantrowitz says. "It's your debt. It's also the student's debt." In the most recent academic year, 90.57% of private undergraduate loans had co-signers, according to the MeasureOne report.
If you remain in college at least on a half-time schedule, you can defer payment of your federal undergrad and graduate student loans until you leave school. There is also a six-month grace period after college ends before students have to start paying back their loans.
There is no guarantee of a post-graduation grace period for private loans -- they vary depending on the lender. It's common for lenders to offer four different repayment plans:
-- Deferred. Begin paying principal and interest after you leave school. Payments can be delayed up to nine months, depending on the lender. Six months is common.
-- Interest only. Make interest payments while you're in school to reduce the overall cost of the loan.
-- Partial. Make a fixed monthly payment while you're in school. Lenders frequently set it at $25.
-- Immediate. Begin paying principal and interest right away. This has the highest in-school cost but is the lowest overall cost option.
Hardship and Support
If you run into trouble finding a job, become disabled, don't earn enough to pay back your loans in full or are affected by a major economic event such as the coronavirus pandemic, the chances are much better that you can get assistance -- whether it's deferred payments or another type of relief -- through federal student loans.
"The options for relief are just so stark between the two products. That's why I almost always recommend federal over private," says Betsy Mayotte, president and founder of The Institute of Student Loan Advisors. For example, federal loan programs allow:
-- Postponement. The federal government instituted forbearance for all federal student loan borrowers because of the pandemic, allowing them to hold off on payments from March 2020 until at least September 2021. Borrowers could stop making payments, and interest stopped accruing. In nonpandemic situations, you can enter into a deferment or forbearance agreement with approval from your loan servicer, although interest will accrue during the period when your payments are delayed.
-- Income-driven repayment plans. If deferment or forbearance isn't enough, you can sign up for one of four income-driven repayment plans, which could limit payments to 10% to 20% of your discretionary income.
-- Forgiveness or discharge. The federal loan program can provide loan forgiveness through the Teacher Loan Forgiveness program or, if you work at a not-for-profit or government organization, through the Public Service Loan Forgiveness program. Also, loans can be discharged for multiple reasons, including disability or a closed school.
Private borrowers might offer some of these programs, but they aren't guaranteed. "But for the most part, there are very few opportunities for relief for those borrowers," Mayotte says.
Some private lenders have offered coronavirus relief, for example, but borrowers need to apply for the loan forbearance and it's only available on a short-term, month-by-month basis. In all cases, interest still continues to accrue.
How to Choose Between Federal and Private Student Loans
If you're trying to decide which loan type -- federal, private or a combination of both -- is best for you, it might be best to start with the cost for each, both in the short term and for the life of the loan. Federal loans are "generally going to be cheaper and more available," Kantrowitz says.
Even though it might take some time to estimate how much you will borrow over the course of four or five years, it's important to start figuring out how much you can handle for loan payments after graduation before you take out your first loan, Mayotte says.
Follow these pointers from Mayotte when you take out loans: "Don't borrow assuming forgiveness, don't borrow more than you can afford to repay, and do some projections based on your first year of anticipated borrowing rather than having it catch you off guard" after graduation, she says.