Federal vs. Private Student Loans: What's the Difference?

There’s no doubt that paying for college can be really stressful. Tuition, room and board, books, food—it all starts to add up fast. So it’s no wonder that tons of people (around a whopping 44 million total, in fact) have turned to student loans to pay for school.¹ And lenders make it all too easy to get in over your head.

Between private student loans and federal student loans, the amount of total student loan debt is weighing in at over $1.6 trillion.² That number of commas and zeroes is unreal!

Look, the best student loan is no student loan. It is possible to go to college without digging yourself into a hole you can’t get out of. So, before you sign years, possibly even decades, of your life away to the federal government or some big box bank, let’s take a look at federal vs. private student loans. You’ll be able to make a much better decision about your future when you’re armed with the facts.

What Is a Private Student Loan?

A private student loan comes from a bank, credit union, state loan agency or some other kind of financial institution. These are non-federal funds you can use to pay for school.

Before we dive into the differences in federal vs. private student loans, we’re going to have to do a little bubble bursting first. Here’s the truth: Private student loan lenders are out to make money. They exist to make a profit, not because they’re dying to see you walk across that stage in your cap and gown. OK, now that we’ve ripped that Band-Aid off . . .

In general, students (or their parents) turn to private student loans to make up any difference federal student aid can’t cover. Let’s say Elizabeth gets into a small liberal arts college that costs $48,000 per year. After receiving the max annual amount of $12,500 in federal student loans, she still owes $35,500. With no other savings, grants or scholarships in place, Elizabeth and her parents head to the bank to apply for a private student loan to cover the difference.

Getting a Private Student Loan

Not just anybody can get a private student loan. Because lenders are most often dealing with borrowers who have little to no established credit, they’ll require a cosigner (someone who is legally committing to pay back the loan if the borrower doesn’t).

Here’s what they’re looking for from borrowers and cosigners:

• Credit score
• Credit history
• Income
• Debt-to-income ratio
• Length of employment with current employer

But cosigners, beware. Almost 11% of student loans are delinquent or in default (meaning payments haven’t been made on time), so get ready to pony up if your borrower falls behind.³ 

Private student loans don’t require the Free Application for Federal Student Aid (FAFSA), which helps you find financial aid you might not have known you could get. So, make sure you fill one out.

Almost all lenders will do what’s called a school certification. This means the school will need to confirm the student’s enrollment status and their loan eligibility, plus show that the amount of the loan doesn’t exceed the cost of the school, including any help from federal aid, grants or scholarships.

Private Student Loan Interest

Remember, how we said private student loan lenders are out to make a buck? Well, they make their money on the interest you pay. Private student loans almost always have a higher interest rate than federal student loans. And those higher interest rates mean more money in the lender’s pocket.

Ready to get rid of your student loans once and for all? Get our guide.

While the interest rate on private student loans will vary from lender to lender, on average, fixed interest rates are around 4.29–12.49%. Average variable rates run from 1.8–14.18%.⁴ You might be able to snag a lower interest rate than what the federal government offers if you have excellent credit. Don’t count on it though. Private lenders don’t need to compete with the government. They’ve got you right where they want you: federal aid maxed out and still in need of more money.

Private Student Loan Repayment

There’s no set limit for how much you can borrow in private student loans. Instead, it maxes out at the total school-certified cost to attend. So, if you choose a really pricey college, or plan on being in school a long time (we’re looking at you future docs), those loans could go up and up.

Most private student loans offer 20- or 25-year repayment terms. Think about that. You could still be paying on your student loans by the time your child goes to college. That is not OK.

Each lender will set their own repayment terms, interest rates and any other fees like late fees and default fees. Some lenders won’t require repayment until after graduation plus a grace period of usually six months. But others might put you on a repayment plan for interest-only payments or reduced payments while you’re still in school.

What Is a Federal Student Loan?

Federal student loans are funded by the U.S. Department of Education for borrowers to put toward college or career school. The federal government’s student loan program is called the William D. Ford Direct Loan Program, or Direct Loan for short.

In order to be eligible for a student loan, you have to fill out the FAFSA every year. If you’re a dependent student, meaning someone else claims you on their taxes, then the person who claims you must also fill out the FAFSA.

This application lets the government know about your financial situation by asking you to report things like savings and checking account balances, investments, untaxed income like child support and more. They’ll use this information to determine what kind of aid you’re eligible for, including loans, grants and work study programs.

Most federal student loans don’t require a credit check. Why? Because so many people applying for federal student loans are incoming college freshmen or college-aged students with little or no credit to report.

You can take out a maximum of $12,500 in federal student loans annually, and not more than $57,500 total. For graduate and professional students, those limits go up to $20,500 annually and $138,500 total.⁵

Types of Federal Student Loans

There are a ton of federal student loan options out there, and they all fall under a few main categories. Again, to be eligible for any of these loans, you must fill out the FAFSA each year you’re looking for aid.

1. Direct Subsidized Loans: Loans for undergraduate students who show financial need.
2. Direct Unsubsidized Loans: Loans for undergraduate, graduate or professional students; not based on financial need.
3. Direct PLUS Loans: Loans for graduate and professional students or the parents of undergraduate students to pay for school expenses not covered by other financial aid. Financial need doesn’t determine eligibility, but a credit check is required.
4. Direct Consolidation Loans: More on this in a moment, but this type of loan combines all your federal student loans into one loan with one payment to one loan servicer.

Federal Student Loan Interest

Federal student loans almost always come with a lower interest rate than anything you can find from a private lender. Each year, the federal government sets the range of interest rates for student loans for the next academic year.

For 2019–20, the interest rate for Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduates is 4.53%. Direct Unsubsidized Loans for graduate and professional students have an interest rate of 6.08%. And the interest rate for Direct PLUS Loans comes in at 7.08%.⁶

Federal Student Loan Repayment

Most federal student loans come with a 10-year repayment plan, plus a six-month grace period after graduation before you have to make your first payment. But like most things involving the government, paying back your federal student loans can get unnecessarily complicated. The main thing to know is you’ve got a bunch of repayment options.⁷ Let’s take a look at a few of them.

Standard Repayment Plan

This is the most basic, straightforward repayment plan. You’ll pay a fixed amount each month so that your loans are paid back within 10 years.

Pay As You Earn Repayment Plan (PAYE)

With the PAYE Plan, you’ll make monthly payments that equal 10% of your “discretionary income,” or what you can afford to pay based on the size of your family and your adjusted gross income. Your monthly payment can’t be more than what it would be under the Standard Repayment Plan though. If you’re married and file jointly, your spouse’s income (and loan debt) will be factored in.

Income-Based Repayment Plan (IBR)

Like the PAYE Plan, the IBR plan looks at your discretionary income as the measuring stick for your monthly payments. Under this plan, your monthly payments may be between 10–15% of your discretionary income, but not more than you would pay under the Standard Repayment Plan.

What’s the Difference Between a Federal and Private Student Loan?

Not all loans are created equal. (But spoiler alert: They all stink.) Here’s an overview of some of the main differences in federal vs. private student loans.

	Federal Student Loans	Private Student Loans
How much can I borrow?	For undergrads, up to $12,500 annually, or $57,500 total. For graduate or professional students, $20,500 annually, or $138,500 total.	Varies from lender to lender, but no more than the total cost to attend the school. Buckle up, that could be a lot of dough to pay back!
What’s the type of interest rate?	Fixed	Variable or fixed
What’s the interest rate?	Depending on the loan type, between 4.53–7.08%.	Rates vary by lender. Average fixed rates range from 4.29–12.49%, and average variable rates run from 1.8–14.18%.
Is a credit check required?	For Direct Loans, no. For graduate students and parents applying for PLUS Loans, yes.	Oh, you betcha.
What are the repayment terms?	Standard terms are 10 years.	Terms vary by lender but could range anywhere from five years all the way up to 25 or more years. Talk about a nightmare!

Student Loan Consolidation and Refinancing

Consolidating and refinancing are both options to help you get on top of your student loan payments. But whether you should do either depends on the kind of student loans you have.

Student loan consolidation lets you take your federal student loans and roll them into one loan (aka one payment). It takes the weighted average of the interest rates on your current loans and gives you one fixed rate.

But what usually ends up happening is you also get a lower monthly payment because you’re extending the length of your loan. You don’t save money in the long run because you’re paying interest for a longer amount of time. Student loan consolidation is the only type of debt consolidation we’re okay with. But if you’re not laser focused on blasting through this debt, you’ll come out deeper in the red than before you consolidated.

Student loan refinancing, on the other hand, is for private student loans (or a mix of federal and private). When you refinance, a private lender pays off your student loans and gives you a new loan with new repayment terms. The goal here is to get a lower interest rate. But don’t refinance if the process costs money, you’ll get stuck with a variable interest rate, or it’ll extend the length of your loan.

Whatever you do, don’t take your foot off the gas pedal. You want to attack your student loans until they are going . . . going . . . gone!

Are Private or Federal Student Loans Better?

Deciding whether private or federal student loans are better is like comparing villains. Who’s better at doing terrible things—the Joker or Lex Luthor?

Federal student loans typically offer lower interest rates and better repayment terms. They also have some limits in place to prevent you or the people who claim you from borrowing a kajillion dollars. But if your schooling is going to cost an arm and a leg, then chances are good that federal student loans aren’t going to cover it.

Private student loans are risky business. You can borrow and borrow and borrow some more. You can get locked into variable rates that start out great and hamstring you later. And with repayment terms that extend into multiple decades, you could be paying on your student loans as long as you would for a home. So, that’s a hard no.

We’ve said it before and we’ll say it again: The best loan is no loan. It’s 100% possible to get a college education without student loans. Parents and students are doing it every single day. And you can too. Anthony ONeal’s book Debt-Free Degree is a step-by-step guide to paying for college without going into debt.

Getting Rid of Student Loans

Maybe you’ve already taken out student loans and they’re stealing your peace of mind. You’re not alone. Most of us learn financial lessons the hard way—or as we like to put it: We pay the stupid tax. It’s the price of admission to a new and better way of taking control of your money.

Getting out of student loan debt isn’t as easy as getting into it, but the payoff is way better. To get started, check out Anthony ONeal’s 64-page Quick Read, Destroy Your Student Loan Debt. He’s going to teach you how to budget, create an emergency fund, and accelerate your debt snowball to pay off student loans faster.