A student loan helps pay for college, career school, or technical schools. Some student loans are based on financial needs, while others are based on your credit score—both need to be repaid with interest. It is essential to understand what types of loans you are offered as choosing the right student loan will help you save money, both in principal and interest.
There are two types of student loans: federal student loans are loans funded by the federal government, whereas private student loans are non-federal loans offered by a lender such as a bank, credit union, state agency, or a school.
Federal student loan
Four types of direct loans are William D Ford Federal Direct Loan (Direct Loan) Program. Direct subsidized loans are offered to eligible undergraduate students based on financial need whereas unsubsidized loans are not based on financial needs and are offered to eligible undergraduate, graduate, and professional students.
Direct PLUS loans are offered to graduates or professional students and parents of dependent undergraduate students, whereas direct consolidation loans combine all of your eligible federal student loans into a single loan with a single loan servicer.
Only undergraduates and graduate students with exceptional financial need are eligible for the Federal Perkins Loan Program administered through the schools. Opt for this loan first, if you are eligible.
To get a federal loan, check whether you are enrolled at a school that is a member of the school loan program and that you meet the general eligibility requirements. The next step is to complete the Free Application for Federal Student Aid or FAFSA. You must complete this form within the specified deadline to be eligible for any federal student loans or grants.
Private student loans
Make sure you have explored all options such as scholarships or getting a part-time job or finding a low-cost school before taking out a private loan. Borrowing beyond your capacity may land you in debt.
Private loans come in a variety of types and usually require a cosigner. For example, there are state agency loans offered by states to residents or students attending school in the state. Then there are the traditional commercial bank loans that usually require a cosigner. Some schools also offer fixed-interest loan programs for students, so do ask your school’s financial aid office for information.
When deciding on a private loan, it’s important to shop around, study multiple lenders and compare the different loan offers. If you can show the ability to repay, you may be able to find lower interest rates and borrow larger amounts.
It is also essential to know the track record of the lender and to assess the terms of the loan to save yourself from fraud and identity theft. Don’t be swayed by promotions or incentives such as gift cards and sweepstakes prizes. Also, do not give out personal information on the phone, through the mail, or over the Internet.
And just in case if you have concerns about your loan, you can request the aid of the Consumer Financial Protection Bureau’s private student loan ombudsman.
Federal versus private loans
Let’s look at the differences between federal and private student loans.
When paying for higher education, federal student loans offer several advantages over private student loans such as a fixed interest rate and income-driven repayment plans, which are not usually offered with private loans. They are also more affordable.
As compared to private student loans that require payments while you are still studying, you do not have to commence repaying your federal student loans until you graduate, leave school, or change your enrolment status to less than half-time.
The interest rate is fixed and much lower than private student loans that usually have variable interest rates (sometimes more than 18%). A variable interest rate can astronomically increase the total amount you repay. Also, since private student loans are not subsidized, you are the one who pays the interest on your loan.
However, if you are an undergraduate student with financial needs, you can qualify for a subsidized federal loan, where the government pays the interest while you are in school on at least a half-time basis. The interest may also be tax deductible.
A private student loan depends on your established credit record, whereas most federal student loans (except for PLUS loans) don’t need a credit check or a cosigner. What’s more? These federal loans can help you establish a good credit record.
You also have the option to consolidate federal student loans into a Direct Consolidation Loan, which is not a possibility with private student loans.
Student loans often run into thousands of dollars, so just in case you are having trouble repaying your federal student loan, you may be able to temporarily postpone or lower your payments. There is no prepayment penalty fee. You also have a chance to have a portion of your loans forgiven if you work in public service. Private lenders usually do not offer deferment options or a loan forgiveness program.
Do compare the terms and costs of both to arrive at your best student loan option.
