Federal vs. Private Student Loans

Knowing which way to go to fund your education.

Comparing private and federal student loans

How you decide to fund your education is a critical decision. The same goes if you’re helping your kids. The right choices set you up for success. On the other hand, the wrong choices can leave you in a bind for decades to come.

There’s also a big difference in how you get help for federal loans versus private loans, and what damage they can do to your financial outlook if you fail to pay. So if you’re behind, it’s important to know which loans you have so you can find the right way to move forward.

Fact: Federal student loan interest rates are now set according to the 10-year Treasury bond index plus 2 percent.

Are your loans through FAFSA?

The one really easy way to tell if your loans are federal or private is whether they originated from a FAFSA application or not. When you’re planning ahead for college or attending a university, you fill out the Free Application for Federal Student Aid.

When you apply, the government can issue several types of aid, including on-campus work programs, grants, and government-backed student loans. So any loans that come out of that application are federal loans.

On the other hand, if your loan came (originated) from a private financial institution like your bank, a corporate lender or a private financial institution, then it’s a private student loan.

What are the differences between the two?

Besides where the loans came from, there are some key differences that are important to know about:

  • Federal student loan applications don’t involve a credit check; private do.
  • Interest rates on federal loans are set by Congress; private student loan interest rates are set according to your credit score.
  • Federal student loans can be consolidated effectively (and affordably) through most student loan consolidation programs you see advertised; private loans require a different solution if you need debt relief.

Pop Quiz

True or false: One of the advantages of a private student loan is that your parents can cosign for you. Parents can’t cosign federal student loans

a) True

b) False

Reveal Answer

Parents may also cosign federal student loans. In fact, parents can take 100% ownership of federal student loan debt on behalf of a child.

b) False

Return to question

It the past, there was also a difference between the two when it came to discharged debt during bankruptcy. Federal loans can’t be discharged – you’re pretty much on the hook for the debt once it’s incurred. Prior to 2005, you were able to discharge private loans, but Congress closed that gap with the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Now private student loans are treated as if they were federal – so no discharge.

Knowing when each type of loan is better

So what’s the better loan to get and when should you take out each type of loan if you want to avoid problems down the road?

In most cases, the answer is federal student loans. This is especially true for students who just graduated from high school. Most young people won’t have the credit score necessary to qualify for low interest on private student loans. The interest rates offered by Congress on federal loans – while not perfect – are almost always lower than what you can qualify for on a private loan.

That said, let’s say you’re not just out of high school. Instead, you’ve been in your career for 15 years and simply want to go back for your master’s degree. You have nearly perfect credit, you own a home that’s practically paid off and you’ll be working full time at your current pay level while going to school part time. In this case, you may be able to just as easily fund your education through a private student loan. Or you can get a mix.

But again, in most cases, the best choice is almost always to go through FAFSA first. If you need more money and FAFSA won’t cover it, then consider your finances carefully and decide if using supplemental private loans is the right choice in your situation.

Fact: You will need your FAFSA PIN number if you want to consolidate. Always keep this number handy.

What happens when you decide to consolidate?

Private student loans and federal student loans can’t be consolidated together. All of the solutions talked about in the Student Loan Help section of this website are all geared around federal student loans.

That doesn’t mean you’re just stuck if you have private loans that are causing problems. You just have to use different programs specifically designed for private loan relief or talk directly to the lender to work out a repayment plan that works for your budget.