For most students, wrapping their head around the obscenely expensive student loans that come due at graduation is an exercise in keeping vomit down. But we must calculate these numbers, and figure out how deep in the hole we are, because — make no mistake — most of us are in the hole when it comes to student debt. But there is a big difference between federal loans and private loans. You should probably know what those differences are.
Types of federal loans
Direct Subsidized Stafford Loans
Considered to be the friendliest loans — where students and their bank accounts are concerned — DSSLs have pretty amicable terms of payment. However, only those who fall under a certain financial need threshold can receive them. For those who do, the government will pay off the interest during school until repayment starts. These loans are available only to undergraduate students, and the eligibility/size of the loans are based on individual financial needs of the student. Additionally, students do not pay interest while enrolled, nor do they pay during the six-month deferment period post-graduation. After that six-month period elapses, however, interest payments begin.
Direct Unsubsidized Stafford Loans
Direct Unsubsidized Stafford Loans, or DUSLs, are, you guessed it, unsubsidized federal loans. That means they are more widely available, and the threshold for receiving the loans are not as stringent as with the subsidized loans. However, the government will not cover the interest payments before the repayment period, as is the case with the subsidized loans. These unsubsidized loans are available to undergraduate and graduate students alike, and there are no financial-need requirements. Interest payments are requisite for students from start to finish. Although payment can be deferred until the grace period ends, all interest will be added to the principal balance at the start of repayment.
Direct PLUS Loans
These are loans for parents of undergraduate students and graduate/professional students. They can cover as much as is needed for a parent or graduate student to cover their costs. They also take into account the applicant’s credit history. Making them the only federal student loan program to do so. You must have decent credit to be eligible for a Direct PLUS loan, however.
Private student loans and the qualifying process
Private student loans are not funded by the government (clearly), and the applications are subject to similar standards of approval as a typical credit application. This means that an applicant’s credit history can very often make or break their chances of being approved for a private loan.
Federal loan procedures
- Applicants are approved after filing the Free Application for Federal Student Aid (FAFSA); there is no other application.
- Loan offers are based on family income, expected contributions and financial need.
- The only time credit history matters would be if you are applying for a Direct PLUS Loan.
- No cosigner is needed.
Private loan procedures
- Lenders have their own loan applications as well as eligibility criteria.
- Loan offers are based on credit history and income in most cases.
- Other factors such as employment, school or major may factor into your eligibility in some cases.
- Unqualified borrowers may need a cosigner, which is accepted on applications.
When applying for a private student loan
The process is quite varied in the private sector. For instance, each bank has its own student loan application process, which typically involves an online application, a credit check and other documents, too. You should check each individual private lender’s website to find out what their application process entails. The variable details are good to have a handle on.
When applying for a federal student loan
Applicants for federal student loans must complete the FAFSA each year, which is required to be eligible for federal financial aid for higher education The application opens annually on Oct. 1 and remains open for more than a year afterward. For the 2018-2019 school year, the window of completion is from Oct. 1, 2018 to June 30, 2019.
The government will let you know what sort of financial aid, including student loans, you will be eligible for.
Private loan: The cost of borrowing
These rates are set by lenders themselves. But the rates are set by a standard from the U.S. Treasury Department. Low rates are generally somewhere between 3.6 percent up to 13 percent. Although, again, the range of rates will vary by the individual lender. The vacillating nature of lender discretion is a major variability factor in choosing private loans over federal funds. Although it varies, in general, a person with good credit can expect something closer to 3.6 percent while a person with bad credit can expect a higher rate closer to 13 percent.
Variable vs. fixed loans: Private lenders, unlike federal lenders, offer variable and fixed rates (these can have an impact on the cost of your loan). These variable-rate loans usually offer lower APRs. Also, such rates are liable to fluctuate with the market, so they could end up rising or falling over time. Fixed-rate loans are generally offered at higher APRs relative to variable-rate loans, but they do not fluctuate with the market after the loan is disbursed.
Federal interest rates
These rates are based on the market and are — unlike private loans — fixed-rate loans. That means that there will be no fluctuation in APR during repayment. Since federal loans are broken out simply by the program, it’s much easier to break down the interest rates. Here is a list of the current federal rates for loans taken out after July 1, 2017:
- Direct Subsidized Undergraduate Loans: 4.45 percent
- Direct Unsubsidized Undergraduate Loans: 4.45 percent
- Direct Unsubsidized Graduate/Professional Loans: 6 percent
- Direct PLUS Loans: 7 percent
- Perkins: 5 percent (discontinued)
Fees and penalties
When it comes to federal student loans, there are fees to know about. One such fee is the origination fee. Direct subsidized and unsubsidized student loans come with a 1.066 percent loan fee on loans disbursed between October 2017 and October 2018. Direct PLUS loans come with a fee of 4.264 percent if disbursed over the same time period.
Although many private lenders boast no origination fee, they often sneak it in as a percentage of the loan amount.
Prepayment penalty fee
Federal student loans are completely devoid of the above prepayment penalty, and most private lenders will not charge the aforementioned origination fee. But, again, it varies on a case-by-case basis.
Federal repayment options are far more flexible than private loan repayment options. There are four different categories of repayment plans for student loans.
Ten-year standard repayment plan:
Can be paid over 10 years in 120 payment installments
Graduated repayment plan
Involves 120 payments over 10 years, but payments start low and gradually increase over time.
Extended repayment plan
This is 300 installment payments over 25 years. The borrower can choose a standard or graduated repayment schedule.
The four IDR plans
IDR stands for income-driven repayment plans. They are an income-based repayment plan (IBR), an income-contingent repayment plan (ICR), an income-sensitive repayment, also known as PAYE (pay as you earn), and lastly the revised pay as you earn repayment plan (REPAYE). All of the plans above listed have monthly payment plans based on discretionary income, and repayment terms vary from 15 to 25 years. Some, if eligible, can have their remaining balances forgiven after the repayment term is up.
Private student loan repayment options are extremely more stringent. The standard is a 10-year repayment plan across 120 installments. But student borrowers can find plans ranging from five to 15 years.
Takeaway: Feds or private. Which is better?
Federal student loans are the obvious winner. Availability, interest rates that are more equipped to manage the needs of college students who are new to the credit world, a six-month grace period and deferment options are only a few reasons why you should go federal with your student loans. Another reason includes the private spheres’ flexible repayment options. Try to get federal student loans first, and only then turn to private-sector lenders as a last resort to cover any remaining expenses.
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