Student Loans: Federal Versus Private

Federal loans versus private loans

A student loan is money you borrow to pay for college or career training. You must pay it back with interest. There are two big families of student loans, and the main difference is who the lender is.

• Federal student loans are made by the U.S. government through the Department of Education. You apply by filing the FAFSA.

• Private student loans are made by banks, credit unions, and online lenders. You apply directly to the lender.

Why does the difference matter? Federal loan terms are set by law and do not base the rate on your credit, so students without a credit history can borrow and get extra protections. A private lender is a business. It charges a rate based on how risky you look, and it asks for a cosigner when you have no income or credit history.

A cosigner is a person, often a parent, who promises to repay the loan if you do not. If you miss payments, the cosigner's credit score is hurt and the lender can collect from them.

Federal loans also have borrowing limits, and federal law changed some loan rules and repayment plans in 2025. Check studentaid.gov for the current limits and options.

A fixed rate stays the same for the whole loan. A variable rate can go up or down over time as market rates change. It may start low and then rise.

Subsidized versus unsubsidized loans

Most federal loans for undergraduates are Direct Loans. They come in two types.

• A Direct Subsidized Loan is for students with financial need. The government pays the interest while you are in school at least half-time, during the grace period after you leave school, and during deferment.

• A Direct Unsubsidized Loan is available whether or not you show financial need. Interest accrues from the day the money is paid out, including while you are in school.

To accrue means to build up. Interest accrues on a loan even if you make no payments. If you do not pay it while you are in school, it piles up. When repayment starts, the unpaid interest is usually added to the principal. This is called capitalization. After that, you pay interest on a bigger balance.

The simple interest formula tells you how much builds up:

where $P$ is the principal (amount borrowed), $r$ is the annual rate as a decimal, and $t$ is time in years.

What a loan really costs

The sticker rate does not tell the whole story. To compare loans, find the total amount repaid and the total interest. Most student loans are repaid in equal monthly payments.

The federal standard repayment plan lasts 10 years, which is $10 \times 12 = 120$ monthly payments. A 20-year plan has $240$ payments.

This is the main trade-off of repayment plans. A longer term gives a lower monthly payment (easier on your budget now) but a higher total cost, because interest has more time to build. A shorter term costs more each month but saves money in the long run.

Choosing a loan wisely

Numbers are only part of the decision. Use the decision process from earlier in this course: identify the problem, gather information, list your options, weigh advantages and disadvantages, choose, and evaluate.

Here are the factors to weigh when you compare a federal loan with a private loan.

Borrow federal first. Federal loans have repayment protections that most private loans lack:

• Deferment: a pause in payments in certain situations (such as returning to school or economic hardship). Interest may still accrue on unsubsidized loans.

• Forbearance: a temporary reduction or pause in payments when you cannot pay. Interest generally keeps accruing.

• Income-driven repayment plans: payments are tied to your income. Federal rules for these plans have been changing, so check studentaid.gov for the current options.

Look at the cosigner's risk. If a private loan needs a cosigner, that person is legally responsible for the debt. A missed payment hurts both credit scores.

Think about a job loss. If you lose your job, a federal borrower can ask for deferment, forbearance, or an income-driven plan. A private borrower must negotiate with the lender and may get no help.

Check the rate type. A fixed rate is predictable. A variable rate may start lower, but your payment can rise.

Borrow only what you need. A common guideline says your student loan payments should be at most about $10\%$ of your gross income (income before taxes).

If a plan does not fit the guideline, you can extend the term (lower payment, more interest), borrow less, or look for grants and scholarships first. If a plan fits, you can still pay off the loan sooner by paying extra toward the principal. That reduces the interest you pay.

Summary