A Comparison of Federal Student Loans vs. Private Student Loans

Federal student loans and private student loans are opposites in many ways but, for millions of students across the country, the two types of loans work together to pay for undergraduate, graduate and doctoral degrees.

Therefore, when talking about federal versus private student loans, the discussion isn’t so much about which one is better because, in the end, many borrowers will have to use both.

In this guide to federal and private student loans, we’re going to compare the two loans in five different areas: interest rates, loan limits, repayment options, credit and co-signers, and fees.

To help supplement our own research of private and federal loans, we reached out to experts in various education and finance related fields. The team we assembled for this article are:

  • Jill Rayner, financial aid director, University of North Florida
  • Joseph Havis, director of enrollment management, Fontbonne University
  • Margie Brickner, president and CEO, Reliant Capital Solutions
  • Jeremy Wine, student loan supervisor, Take Charge America

After we cover the five areas we mentioned earlier, we’ll conclude with a section featuring advice from our expert sources.

Interest Rates for Federal and Private Student Loans

Like any normal loan, the student loans you get from the federal government or a private lender are going to have interest rates.

The biggest difference between the types of interest rates you get from the government as opposed to a private company like Sallie Mae is that your federal student loans have compounding interest.

What this means is that the interest rate on your loan is calculated daily by multiplying your daily balance by your daily interest rate, which is your loan’s APR divided by 365. In this sense, federal student loans are very much like a credit card balance, which also calculates interest with a daily rate.

This, says Jeremy Wine, a student loan supervisor at credit counseling non-profit Take Charge America, is the main weakness of federal loans. Since interest is calculated daily, it can build up rather quickly and end up costing more than the loan itself.

“Regarding weaknesses, federal student loans still have interest that accrues on the loans. This means that borrowing a significant amount of federal loans results in a higher payment and can cause a borrower to pay back more than the initial cost and potential value of the loan,” he said.

Private student loans, on the other hand, are fixed-rate loans with equal payments for the life of the loan. There is no compounding interest.

Therefore, one of the first things you’ll notice about private student loans is that their interest rates are, for the most part, higher than federal student loans.

The following chart shows you interest rates for private and federal loans at the time of publishing:

  Ascent Sallie Mae Wells Fargo Discover Citizens Bank Federal Aid
Undergrad Loans  5.54% - 14.59% 5.59% - 11.60%   5.94% - 12.15% 5.99% - 12.99% 6.45% - 12.05% 5.05%
Graduate Loans  5.54% - 14.59% 6.00% - 8.91%  6.84% - 11.17% 5.99% - 13.99% 6.39% - 11.44% 6.6%
Law/MBA  5.54% - 14.59% 5.99% - 8.91%  6.84% - 11.17% 5.99% - 12.99% 6.05% - 10.05% 6.6%
Medical Doctorate  5.54% - 14.59% 5.99% - 8.61% 6.66% - 9.68% 5.99% - 11.24% 5.56% - 9.21% 6.6%

Based on our research of private student loans, we find that, if you have the credit scores to get the best rates on loans for graduate school or doctoral work (more on that in a few minutes), then private loans are the smarter choice because you’ll get lower interest rates.

Jill Rayner, the financial aid director at the University of North Georgia, said her department always recommends that students take out federal loans first when it comes to interest.

“The interest rate and how it’s calculated is better for federal loans,” she said. “Generally, the cap on federal student loan interest rates is 8.25%. With private loans, the interest rate is higher.”

She brings up a good point. While we tend to focus on the lowest APR available from a private lender, their high-end APR’s can eclipse, as is the case with Ascent, 14%. According to Rayner, federal loans cannot get that high.

One more variation between private and federal loans is that most private loan lenders offer variable-rate loans. These loans have lower APR’s, but those APR’s are tied to the prime rate the government sets. When the prime rate goes up, as it has by more than 1% in the past couple of years, then your interest rates go up, too.

Federal student loan interest rates increase from year to year, in most cases, but your loan maintains the interest rate you were quoted when you signed for them. If you get a federal loan at 5.05%, then the rate for that loan stays at 5.5%.

Limits on Federal and Private Student Loan Amounts

As we mentioned earlier, federal and private student loans tend to work together when a student has exhausted all financial aid possibilities and needs to fill a gap in their funding. This happens because the government places a limit on how much student loan money you can borrow.

if your parents are claiming you as a dependent, then the most subsidized and unsubsidized federal loans you can borrow your first year is $5,500, your second year the max is $6,500 and your third and fourth years that goes up to $7,500.

If nobody is claiming you on your taxes then you’re an independent taxpayer and you limit goes up to $9,500, $10,500 and $12,500 in your freshman, sophomore and junior/senior years.

“The most significant disadvantage of federal student loans is that there are limits to the amount you can take in these loans,” said Joseph Havis, director of enrollment management at Fontbonne University.

Private loans work differently. In most cases, the lender will calculate how much they’ll give you based on how much it costs to go to school. The loan they give you won’t exceed the cost of school, which is a good thing in the sense that it protects you from borrowing more than you need.

So, if your parents claim you on their taxes (dependent) and tuition and the necessary additional expenses cost $15,000 your freshman year, then your federal student aid maxes out at $5,500, leaving you with $9,500 that you have to pay for.

Private loans can fill this gap by providing the $9,500. Typically, the money is sent to your school’s business or financial aid department. In the case of some specific private loans for the bar exam and medical residencies, the money will go to your bank account.

Federal and Private Student Loan Repayment Options

Perhaps the area of greatest disparity between federal and private student loans is the repayment options you have.

We’ll use Discover’s private loans as an example. They’ll give you the option of repaying only the interest each month you’re in school, paying a $25 a month or having a nine-month grace period after you graduate.

And, in most cases, your private student loans will have to be paid back in 10 or 15 years without the option to extend your repayment via programs similar to what you'd get with the government (more on that in a second).

"Private loans may enter repayment while the student is still enrolled, or could have a shorter repayment term resulting in a higher monthly payment and great financial strain to meet all financial obligations,” said Margie Brickner, president and CEO of reliant Captial Solutions.

Federal loans, on the other hand, don’t require you to pay back your loans until six months after you graduate or drop below half-time. Once you enter repayment, you have eight different options for repaying your student loans.

Three of those options worked off a schedule of fixed payments through which you pay off your loans in 10 or 25 years and the other five calibrate your monthly payments based on your income, family size and discretionary income.

And, as Jill Rayner pointed out, federal loans offer loan forgiveness after certain programs, the most popular of which is Public Service Loan Forgiveness (PSLF), through which employment in certain jobs for 10 years along with 120 payments can lead to the government forgiving your remaining student loan balance.

Credit Scores and Cosigners for Federal and Private Student Loans

When you apply for a private student loan from a company like Wells Fargo, they will check your credit and use it as a significant factor in calculating the interest rate they give you.

While the low rates they advertise on their site are attractive, you have to remember that only those with the best credit scores get those low rates. This present a problem for the average college student who has no credit history has bad credit scores, both of which usually lead to high interest rates.

Private lenders offer to help you get around this by encouraging you to find a co-signer, which, basically, is another person coming along and signing for the loan in the event that you don’t pay up, the lender can go after your cosigner.

The good side of this is that a cosigner with excellent credit scores (above 750) gives you a much better chance at getting lower rates and larger loan amounts.

In general, this requirement for a credit check is one of the downsides to private student loans, Brickner said.

“The largest disadvantage to a private loan is you need solid credit, or in most high school students’ cases, a cosigner with good credit,” she said. “If you don’t have access to good credit, you lose the opportunity to maximize the loan amount and interest rate.”

Federal loans, on the other hand, don’t require credit checks. The published interest rate is what you get, regardless of your credit scores.

» See Also: Comparison of Free Credit Score Websites: Which One Is Best?

Fees and Discounts for Federal and Private Student Loans

One of the more interesting areas of the federal and private loan debate is that of fees and discounts.

Private student loan lenders like Ascent don’t charge fees to give you a loan. Normally, you’d pay a lender an origination fee for a loan of any kind. This fee covers their cost to process your application and give you your loan.

Federal student loans, on the other hand, charge an origination fee of 1.066% for undergraduate loans given up to Oct. 1, 2018, and 1.062% after that.

The origination fee for graduate student loans is four times what you’ll pay for an undergrad loan: 4.264% for loans obtained up until Oct. 1, 2018, and 4.248% after that.

Another distinction between federal and private loans is that private lenders who are also banks tend to give interest rate deductions if you pay your monthly bill via your bank account and you have an account with them.

Federal student loan servicers like Nelnet, Great Lakes and Navient give you a 0.25% deduction paying directly from your bank account.

 Here are the maximum discounts you can get with four popular private student loan lenders:

  • Ascent: 0.25%
  • Sallie Mae: 0.25%
  • Wells Fargo: 0.50%
  • Discover: 0.60%

Additional Advice and Tips

Our experts had a lot to say about federal and private student loans. Some of those insights went beyond the scope of the five sections above. So, we’ve included one additional insight from each expert we interviewed.

Joseph Havis: Use Private Loans as a Last Resort

“The only time we recommend private student loans is in lieu of federal loans in the event it may be more affordable based on interest rates. Overuse of any loans to offset the cost of higher education often leads to loan debt that can become too cumbersome to overcome.

“We recommend to all students that are considering taking out private loans in addition to the federal allotment to work with institutions to understand the true impact of their loan commitment and to ensure all opportunities to obtain a degree have been fully evaluated with value and affordability in mind.”

Margie Brickner: You Might Have to Give Back Your Federal Loans If You Drop Below Half-Time or Drop Out

“The federal aid programs have stipulations which require institutions to return aid that has been borrowed if the student doesn’t pass the course, or withdraws from all or enough courses reducing their enrollment status, and consequently, eligibility for the aid they have already taken.

“Typically, these changes to aid eligibility occur after the ability to withdraw from a course without any financial responsibility has passed. As a result, the institution will return the aid and the student will have an outstanding balance with the school. Many students find this very confusing and don’t realize the consequences or in general that all or part of their aid has been revoked.”

Jeremy Wine: Talk With a Student Loan Counselor Before Making Any Decisions

“Before selecting either federal or private student loans, borrowers should speak first with a certified student loan counselor to discover what options truly exist as well as determine how much the borrower should pay each semester.  Then, as needed, federal student loans should be used prior to private student loans to help finance your education.”

» Related: Essential Things to Consider Before Getting a Student Loan

Jill Rayner: You Can Consult With Your School’s Financial Aid Office After You Graduate

“If you leave the university, we’re still here to help the students and answer questions about your loan. A lot of times, too, students are afraid to ask questions to their loan servicer and they don’t really know which questions to ask, so they don’t call and ask for help and they miss payments or go into default.

“That’s really bad because there are some states where, if you go into default on your student loans, you can lose your certification in jobs where you have to be certified, like a beautician or teacher. It’s real important to use us as a resource. Sutdentaid.gov and the National Student Loan Data System are a huge help, too.”

The Final Word: Be Smart and Know What You’re Getting Into

Federal and private student loans each have their own unique characteristics. If we could sum up the differences between the two, we’d say that federal loans use compounding interest, which can be very expensive the longer it takes you to pay back your loans. However, their interest rates are low and are not contingent on credit scores.

Private loans, on the other hand, offer bigger discounts, don’t charge an origination fee and they can be a better choice, interest-wise, if you have excellent credit scores and are looking for a loan to help you get through graduate school.

Both have their drawbacks, so we suggest doing the very best you can to find scholarships that will help pay for some, if not all, of your college expenses.

If you want to learn more about the various loan options, scholarships and grant programs available to you, read through our other guides:

J.R. Duren

J.R. Duren is a personal finance reporter who examines credit cards, credit scores, and various bank products. J.R. is a three-time winner at the Florida Press Club’s Excellence in Journalism contest. He is a member of the Society of Professional Journalists and his insight has been featured on Investopedia, GOBankingRates, H&R Block and Huffington Post.

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