Which Is Better for Borrowing?

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If you are planning on borrowing money for college, you will have plenty of company. Nearly 45 million Americans hold $ 1.71 trillion in student loans. Before entering into decades of debt, it is important to understand the many key differences between your two main options: federal student loans and private student loans.

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Find out: How do generations compare when it comes to student loan debt?

Federal vs. Private Student Loans – What’s the Difference?

Both government and private student loans must be paid back with interest whether or not you ever graduated from college. The interest you pay on both types of loan is tax deductible. In addition, the differences outweigh the similarities.

Related: College Students’ Guide to Smart Student Borrowing

The main difference is that the federal government finances federal student loans and lenders such as credit unions, banks, government agencies, and universities themselves fund private student loans.

There are four types of federal student loans:

• Direct sponsored loans: These loans offer better interest rates to students who can show a need.

• Direct unsubsidized loans: Students and doctoral candidates can apply without proof of necessity.

• Degree PLUS Loans: These are aimed specifically at graduates and professionals.

• Parent PLUS loan: These are special loans given to the parents of a student.

Apply for federal loans first

One of the other key differences is that you must apply for a federal student loan through the Free Federal Student Aid Application (FAFSA). The deadline for submitting all FAFSA papers for the 2020-2021 academic year is June 30th at 11:59 p.m. Central Time. All updates and corrections are due by September 11th. For the 2021-2022 academic year, the deadlines are 11:59 p.m. Central Time on June 30, 2022, with all updates and corrections due by September 10, 2022. The FAFSA sets your credit limit, which may not cover participation costs, and the FAFSA also determines your eligibility for other state aid such as dual study programs and scholarships.

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For personal loans, on the other hand, you apply directly through the lender and the lender sets your credit limit regardless of your needs. In most cases, a co-signer with good credit will help students obtain personal loans. That is not the case with federal loans.

In general, you should not consider private loans until you have exhausted not just federal loans but grants, scholarships, and other awards as well. This is partly because, unlike the FAFSA deadlines, you can apply for personal loans as late as you want, provided the lender has enough time to process the loan. It is even more important that you should string together federal loans first, as these are usually more flexible, uncomplicated and cheaper than private student loans, which you should usually only use to close funding gaps at the end.

Read: How To Refinance Your Student Loans

There’s a lot to like about federal student loans

With personal loans, the lender sets the terms, which vary from loan to loan, lender to lender, and borrower to borrower. In the case of federal student loans, on the other hand, the conditions are set by law and never change. Not only are federal loans typically cheaper – the current interest rate is 3.73% – but they also offer a number of perks and benefits that most personal loans cannot, including:

• Fixed interest rates as opposed to personal loans which may require fixed or variable interest rates.

• Income-oriented repayment plans that tailor your monthly payment to match your income.

• Deferred payments that you don’t have to make until after you graduate. Personal loans can be deferred, but in many cases you will need to start paying while you are still in school.

• Subsidy – If you can demonstrate a need, the government will pay your interest while you are in school. Private loans, on the other hand, are never subsidized.

• With the exception of PLUS loans, there is no credit check for a federal student loan. In almost all cases, private lenders will check your creditworthiness and set your interest rate accordingly.

• Multiple federal loans can be bundled into one fixed-rate direct consolidation loan. Private student loans cannot, but can be refinanced.

• Federal loans allow students to change their repayment plans even after their loan is completed.

• Students who work in the public sector may be waived part of their federal loans.

See: Two thirds of older millennials are still paying off student debts after 10 years

Parental loans are somewhere in between

Either of the two types of Direct PLUS loans, Parent PLUS loans, have some but not all of the benefits of federal student loans. For example, parents who borrow money through these federal loans can defer payments until their child leaves school as if the student had taken out the loan.

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Although the interest rate is fixed like a student loan, parental loans are never subsidized – the borrower is responsible for all interest. However, this interest is usually still tax deductible and multiple loans can be combined into a direct consolidation loan. Just like students, parents who work in the public sector may have some of their loans waived.

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Last updated: June 11, 2021

This article originally appeared on GOBankingRates.com: Comparing Personal Student Loans To Federal Loans: Which Is Better For Borrowing?

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