How do federal student loans and private student loans differ?

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How do federal student loans and private student loans differ?


You may be more concerned about how you're going to pay for tuition, fees, books and living expenses than with who's cutting the check for college, but there are some important differences to be aware of in the types of loan options available if you're heading to college or graduate school.

Parag Shah, a graduate of Boston University, took out about $185,000 in private student loans and $25,000 in federal student loans. Shah wasn't even aware there was a difference between the types of loans until he started taking an active interest in managing his loans after graduation.

He now knows that there are potential drawbacks to choosing a private lender, including the higher interest rate on his private loans.

Consider the following differences between federal and private student loans before you sign on the dotted line. The type of loan you choose can impact your eligibility for different assistance programs and repayment plans in the future.

The application requirements

Many types of federal student aid require the student, often with the help of a parent, to fill out the Free Application for Federal Student Aid (FAFSA). There are many documents you may need to include with your application, including bank statements, Social Security number and tax records.

You may not need to fill out the FAFSA to apply for private student loans. However, as part of the private loan application process, you may need to share your contact information, income, monthly debt payments and Social Security number.

If you don't have an established credit history, private lenders may require a co-signer. Here are things to consider when asking someone to co-sign a loan.

You may need to include details such as where you're going to school and what degree you're pursuing.

Federal student loans and some private student loans are granted based on the applicant's financial need. However, getting approved for a private student loan could be more difficult because your credit is also a factor.

A co-signer with strong credit could improve your chances of getting approved or help you get a lower interest rate.

Sometimes, students' parents play a significant role in the decision-making process. This was certainly the case for Amy Allen, a copy writer who lives in New York City.

After graduating from Manhattanville College in 2007, she had about $55,000 in a combination of private and federal student loans, but says her mother handled all the loan applications.

When Allen graduated and found out how much she owed, she says she nearly had a panic attack in the school's financial aid office.

If your parents are managing your student loan application process, you should be involved in the application process to better understand your debt load and learn how to manage credit responsibly.

Interest rates

Most federal student loans have fixed interest rates (rates that don't change over the life of the loan) that depend on the type of loan and when the money gets sent to the school or student.

For example, undergraduate Direct Loans to students that are dispersed between July 1, 2016, and July 1, 2017, have a 3.76 percent fixed interest rate.

Private student loans could have either a fixed or variable interest rate (rates that may fluctuate over the life of the loan in line with market interest rates). The private loan's rate can depend on the student's and co-signer's credit, as well as the loan's terms.

Private student loans may have a lower or higher interest rate than federal student loans depending on the lender and applicant.

Interest accrual

With Direct Subsidized Loans and Perkins Loans, the government will pay the interest on the loans while you're in school at least half-time.

With unsubsidized federal loans you don't need to start making payments until after you graduate, but the loans accrue interest while you're at school.

Private loans generally accrue interest from the start. Depending on the lender and your repayment plan, you'll either have to start making payments right away or be able to wait until after graduation.

You may be eligible for interest rate deductions by enrolling in an automatic payment program for both federal and private student loans.

For example, federal loan servicers Nelnet and Great Lakes and private lender Citizens Bank give a .25-percent interest rate reduction if you use automatic payments.

Repayment plans

Both federal and private student loans may give you a grace period between graduation and the first loan payment. After that, you'll make payments according to the terms of your repayment plan.

There are eight different repayment plans to choose from if you have federal student loans. You'll automatically start on the Standard Plan, which requires you to make equal payments for 10 years.

You may be able to lower your monthly payments by switching to a graduated 10-year plan (payments start low and increase over time) or an income-driven plan that bases your monthly payments on your income.

However, staying with the Standard Plan can result in you paying less interest over the life of your loan.

You can change back and forth between any of the federal repayment plans that you're eligible for, and there's no fee for switching.

You'll need to check with private lenders to see which types of loan repayment plans they offer. Many don't have income-driven repayment plans, although you may be able to sign up for a graduated repayment plan or apply to temporarily lower your monthly payments.

No matter if you have private or federal student loans, there won't be a penalty for paying off your loans early.

Loan cancellation, discharge and forgiveness

In some very rare instances, federal student loans may be eligible for cancellation or discharge depending on the type of loan and the circumstances.

For example, your loans could be discharged if your school closes while you're enrolled and you haven't already completed your coursework or transferred to another school.

The government could also discharge your loans if you become totally and permanently disabled, if you die or, in rare cases, if you file for bankruptcy.

Some federal student loans are part of the Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness programs.

In some cases, you may be able to get private student loans discharged during a bankruptcy, but they're not eligible for the federal cancellation, discharge or forgiveness programs.

Loan deferment and forbearance

Loan deferment and forbearance are two ways you may be able to put your federal student loan payments on hold.

During loan forbearance, your payments may be temporarily reduced or suspended. However, your loans still accrue interest during this time.

Deferment is similar, but the government may pay the interest for some types of subsidized federal student loans during deferment.

You may be eligible for deferment or forbearance if you're having trouble making loan payments for reasons including you lost your job, fell ill or your loan payments are equal to 20 percent or more of your gross monthly income.

Amy Allen used the forbearance option to place her federal student loan payments on hold while teaching English in Korea during 2010 and 2011. However, her private student loans weren't eligible, and she had to continue making payments.

While private student loans don't qualify for federal deferment or forbearance programs, some lenders offer similar programs -- if you're experiencing extreme hardship, they may be willing to temporarily reduce or place a limit on your interest rate. However, this is typically at the lender's discretion.

If you have private student loans and you plan to attend grad school, you may not be able to defer your loan payments - potentially forcing you to take out loans to pay for grad school AND to repay your undergraduate private student loans.

Private loans will likely continue to accumulate interest while you're not making payments.

Bottom line

While it may seem easier to apply for private loans, federal loans could have a lower fixed interest rate and may qualify for a variety of assistance and forgiveness programs.

You should complete the FAFSA to see what federal loan offers are available and shop around to try and find the terms that work best for you if you need more loans to cover the costs of college.

If you decide to apply for private student loans, remember the loan terms and requirements can vary from one lender to another.

About the Author: Louis DeNicola is a personal finance writer and educator. In addition to being a contributing writer at Credit Karma, you can find his work on MSN Money, Cheapism, Business Insider and Daily Finance. When he's not revising his budget spreadsheet or looking for the latest and greatest rewards credit card, you might spot Louis at the rock climbing gym in Oakland, California.

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