Federal vs. Private Student Loans: Pros and Cons

Getting ready to continue your education after high school is exciting, but it’s the rare student – or parent or guardian of a student – who isn’t stressed over how to pay for college. 

Even if you’ve already applied for grants and scholarships and you’ve filled out the Free Application for Federal Student Aid (FAFSA®), you may not have enough to cover your college costs.  

To pay for the rest, you may need to take out a student loan. The two main types of student loans are federal student loans and private student loans.  

Over 40 million students in 2021 had federal student loans to help pay the cost of higher education.^[1] If you plan on joining that 40 million, your questions about student loans could probably fill a backpack several times over. So, make some room in there – because we’ve got answers. 

Use our guide to learn the differences between federal student loans and private student loans. Because the more you know, the better loan type or combination of loans you’ll choose to finance your higher learning.

How Do Federal Student Loans Work?

Federal student loans are offered by the Department of Education. A federal loan works like any loan: You borrow money, and you pay it back (plus interest) on a repayment schedule. Private student loans accounted for approximately 7.61% of total student loan debt as of the end of the 2nd quarter of 2021.^[2]

Federal student loans tend to have lower interest rates (which are fixed rates set every year by Congress) but cap the amount you can borrow. And they generally have more flexible repayment plans than private student loans. 

Students apply for federal loans using the FAFSA®. You’ll need to answer questions about your income, your parents’ or guardians’ income and assets and whether they have other kids in college. The FAFSA® determines your Student Aid Index (SAI) with this information.

Every school’s financial aid office uses the SAI to determine the cost of attendance and put together your financial aid package, which can include work-study programs, school scholarships, grants and federal loans.

Types of federal student loans

There are several types of federal loans, including:

• Direct subsidized loans: These are federal student loans for undergraduates. Direct subsidized loans and Direct unsubsidized loans are also known as Stafford loans. The amount you get for Direct subsidized loans is based on financial need. While you’re in school, interest doesn’t accrue on the loan. And loan repayment starts 6 months after you graduate or leave school.
  
• Direct unsubsidized loans: Undergraduate, graduate and professional students are eligible for Direct unsubsidized loans. Eligibility isn’t based on financial need and interest starts accruing as soon as the loan is disbursed (think: your school gets the money). Loan repayment starts 6 months after you graduate or leave school and interest continues to accrue during the grace period.
  
• Direct PLUS loans: PLUS loans are for the parents or guardians of undergraduate, graduate and professional students. A Direct PLUS loan is not based on financial need, but the applicant’s credit score will be checked.
  
• Direct consolidation loans: A Direct consolidation loan combines all your federal student loans into a single loan.

How Do Private Student Loans Work?

A private student loan is any loan that’s not backed by the federal government. These include loans offered by banks, credit unions or online lenders. Schools or other organizations may also offer private loans. 

Many private student loans are offered through Sallie Mae. Sallie Mae also services student loans for other lenders. Private student loan borrowing makes up an estimated 7.6% of the outstanding student loan debt.^[3]

Private student loans are not typically based on financial need, and you don’t complete a FAFSA® to apply for a private loan. The loans are based on the borrower’s creditworthiness (read: reliability paying back debt). Private student loan borrowers typically get their credit score checked.  

Having a co-signer might increase a borrower’s chances of getting a private student loan or could help score them a better interest rate. A private loan might also offer a choice between a fixed or variable interest rate loan.

What’s the Difference Between Federal and Private Loans?

Here are some of the main differences between federal and private student loans:

	Federal Student Loans	Private Student Loans
Credit History Considered	Most do not	Most do
FAFSA® Required	Yes	No
Apply With Lenders	No	Yes
Fixed Interest Rates	Yes	Depends on the lender
Co-Signer Might Help You Qualify	No	Yes

What Are the Pros and Cons of Federal and Private Student Loans?

Here are some of the major pros and cons of both federal and private student loans:

Benefits of federal loans

• Lower interest rates: Federal student loan interest rates tend to be lower than the rates of private student loans. And the interest rate is fixed, which means it won’t change over the life of the loan.
  
• Flexible repayment plans: All borrowers are eligible for income-driven repayment plans. Payments under these plans are based on the borrower’s salary after college. Borrowers can change their repayment plan even after they’ve taken out a loan.
  
• No credit check: Credit checks aren’t required for most federal student loans. A low credit score or having no credit history won’t impact federal student loan approval.

Drawbacks of federal loans

• Origination fee: Federal student loans have origination fees (or loan fees), which is a percentage of your loan amount. For Direct subsidized and unsubsidized loans, the fee is around 1.06% of the loan amount. For Direct PLUS loans, it’s around 4.23%.^[4]
  
• Borrowing limits: Federal student loans have borrowing limits for undergraduates.
  
• Debt collectors can seize your wages: If you default on your federal student loan, federal debt collectors can bypass the courts to seize your tax refunds or garnish your wages.

Benefits of private loans

• Higher borrowing limit: Private student loans may have higher borrowing limits than federal loans.
  
• Statute of limitations if you default: Each state has a statute of limitations that caps how long a creditor must wait before seeking repayment on a defaulted loan. You may be exempt from repaying if your lender exceeds your state’s statute of limitations.
  
• Student loan interest is tax deductible: This is usually the case for both federal student loans and private student loans, with a maximum deduction of $2,500.^[5]

Drawbacks of private loans

• Harder to get: Most private student loans require a credit check, and many students may have an insufficient credit history. In that case, the student may need a co-signer.
  
• Higher interest rates: The interest rates on private student loans are typically higher than the interest rates on federal student loans.
  
• Less repayment flexibility: Private student loans don’t typically have flexible repayment plans. 

Choose the Loan That’s Right for You

What’s right for you and your finances can look different. The answer to financing your higher learning might be a federal student loan. It might be a private student loan. In fact, it might be a combination of loans.