Are Private or Government Student Loans Right for Me?
For most American families, funding a college education requires some type of student loan. In the U.S., there are two types of loans – those issued and backed by the federal government and those issued by banks, co-operatives, and other private sector financial organizations. Deciding whether a government of private student loan is right for you depends on several factors. In this article, we take a detailed look at the two available types of loans to help readers determine the right one for them and their circumstances.
Government Loans – What You Need To Know
Federal student loans are administered by the U.S. Department of Education. They typically have lower interest rates and more flexible repayment plans than private loans. Interest on these loans was indefinitely suspended during the COVID-19 pandemic, but it’s not clear how long the moratorium on interest charges will last.
To qualify for a federal loan, applicants must submit the “Free Application for Federal Student Aid” (FAFSA). The FAFSA asks a series of questions about the student’s and parents’ income and investments, as well as other relevant matters, such as whether the family has other children in college. Using that information, the FAFSA determines each person’s Expected Family Contribution (EFC) to their education. That represents how much money the government believes a person might reasonably be expected to pay toward college out of their family’s resources.
The financial aid offices at colleges and universities decide how much aid to offer by subtracting the EFC from the cost of attendance. Cost of attendance includes tuition, required fees, room and board, textbooks, and other expenses. To bridge the gap between what a particular college costs and what a family can afford to pay, the financial aid office puts together an aid package. That package might include some combination of merit scholarships, federal loans, and paid work-study or on-campus jobs. The difference between “grants” and “loans” is that grants never have to be paid back while loans will eventually need to be repaid.
There are two types of government student loans: subsidized and unsubsidized. Subsidized student loans are for people who receive financial aid and are special because the federal government pays the interest on the loans while the borrower is in school. Unsubsidized loans are available to all students regardless of financial aid received or financial need. However, with unsubsidized loans, a person is required to pay all the interest on the loan – even while attending school. If you qualify, a subsidized loan where the government pays a portion of the interest is the best financial option.
Benefits of government loans include the following:
- No need to pass a credit check
- A low, fixed rate of interest
- Several flexible re-payment options
- No penalty for prepaying the loan’s principle
Some downsides to federal government loans are:
- Low loan limits
- The need to file a new FAFSA form each year to maintain eligibility
- Strict limits on how you can use the money
Private Loans – What You Need to Know
As we mentioned, private loans are those made by a bank, co-operative, or other private sector organization. Unlike government loans, private loans are not based on financial need. In fact, most applicants must pass a credit check to prove their creditworthiness. People with little or no credit history, or a poor credit report, usually need a co-signer on a private student loan. Private loans have higher borrowing limits than most federal loans, and people can apply for a private student loan at any time and use the money toward whichever expenses they choose, including tuition, room and board, books, computers, transportation and living expenses.
Private student loans cannot be rolled into and consolidated using the federal student loan program. However, private lenders can consolidate both private and federal student loans by paying off the government loans and issuing a new private one for the previous government loan. This is referred to as a “refinancing” a loan.
Refinancing with a private lender has some benefits, including getting a lower interest rate. However, you’ll lose the flexible repayment options and consumer protections that come with federal loans. People who have both federal and private loans would be best advised to consolidate the federal ones through the government program and refinance the others with a private lender.
Benefits of private student loans include:
- Less red tape and bureaucracy in the application process
- Loans tend to be for larger amounts
- Terms and interest rates can be negotiated and re-negotiated
Some drawbacks with private student loans are:
- Higher interest rates
- Credit checks are typically required to qualify for a loan
- Stiff penalties if re-payments are missed
Which Loan Is Right for You?
Which loan (government or private) is right for you will depend on your financial and personal circumstances. In most cases, a government student loan is the best option as they charge lower interest rates and the penalties charged for missing a re-payment is not as severe as with a private student loan. A private loan could be a good option if a government student loan is insufficient to cover all your education expenses or if you want a larger loan and more flexibility in how you spend the money. But if a loan is to be used strictly for college or university, then securing a government student loan should be the first option as it is the safest and most cost-effective way to borrow money for an education.