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

College costs are high and still on the rise. According to a recent survey, more than 40% of those who’ve gone to college say they’ve taken out student loans to pay for tuition, books, and other expenses. If you’re considering a student loan, you have two types to consider: federal and private.

The government offers federal student loans, whereas banks, credit unions, and other lenders offer private student loans. Everyone who gets a federal loan will receive the same fixed rate without regard to credit, whereas each private lender sets the loan rate based on your credit. 

Here, we’ll look closer at the differences between these types of student loans and when to consider each one.

Federal vs. private loans

Significant differences exist between federal and private student loans, and it’s easy to get lost in the details. This table lays out the general differences between the two.

	Federal student loans	Private student loans
Undergrad interest rate	Fixed at 5.50%	Varies by lender  Usually higher than federal loans, but could be lower depending on your specific situation and creditworthiness.
Fixed or variable rates	Fixed	Fixed and variable rates are available, depending on the lender
Is a credit check required?	Not required for Direct Unsubsidized and Subsidized loans Required for Direct PLUS loans	Yes, for student and cosigner (if applicable)
How are loan amounts determined?	Financial need and maximum allowable limits	Cost of attendance (COA) Your annual COA may include tuition and costs of books, housing, living expenses, loan fees, and other expenses related to receiving your education
Are subsidized loans available?	Yes, based on need  Interest doesn’t accrue at least half-time while enrolled in school, during a 6-month grace period after leaving school, or if your payments are deferred	No  Interest starts to accrue (build) once the loan proceeds are distributed to you or your school
Is loan forgiveness available?	Yes, if specific criteria are met	No
Are income-driven repayment plans available?	Yes	No
Is interest tax-deductible?	Yes	Yes
Do prepayment penalties apply?	No	Varies by lender
Compare	Federal student loans	Best private student loans

The most important difference between federal and private loans

Federal student loans offered by the government feature fixed interest rates, income-driven repayment options, and the potential for loan forgiveness. 

Banks or other lenders offer private student loans with fixed or variable rates, less flexible repayment terms, and no federal protections.

How federal loans work

The U.S. Department of Education offers federal student loans to students and their parents to help pay for college. These loans come with low, fixed interest rates. While undergraduate students with a financial need may benefit from subsidies, even those without one are eligible.

Only undergraduate students with a demonstrated financial need are eligible for federal Direct Subsidized Loans. In contrast, both undergraduate and graduate students are eligible for federal Direct Unsubsidized student loans. Further, eligibility for this loan type is not based on financial need. 

How to get a federal loan

To apply for a federal student loan, complete a Free Application for Federal Student Aid (FAFSA). It’ll take about an hour to complete. The following image outlines the basic steps you need to follow to complete the FAFSA form. 

After submitting the FAFSA form, you’ll be notified of what aid you qualify for and what types of funds—Subsidized, Unsubsidized, or both—you’re eligible to borrow.

Once you accept the loan offer, your school will disburse your loans. You can use any remaining funds to cover additional education-related costs, such as books and housing. 

You won’t be required to make payments while in school, but interest will start accruing on Unsubsidized loans. Your loan repayment typically begins six months after you finish school or if you fall below half-time enrollment. 

You’ll repay the loan in fixed installments, but your repayment term might change how you repay your loans. 

What is the advantage of federal loans over private loans?

When you need a loan for school, federal student loans should be your first choice. They come with benefits that private loans don’t typically offer.

For example, federal loan rates are fixed and usually lower than what you’d get from a private lender. Plus, you can qualify for funding even if you have less-than-perfect credit.

The repayment benefits associated with federal loans include:

• Repayment options: Federal loans offer the ability to choose a different repayment plan, including the option to start with smaller payments that gradually increase over time, to extend your loan repayment period for up to 25 years, or to make loan payments based on a percentage of your income.

Tip

You can learn more about these programs and benefits in our guide to federal student loan repayment.

• Eligibility for public service loan forgiveness: Certain professions may be eligible to have their loan balance forgiven through the PSLF program if specific criteria are met.
• Deferment and forbearance: If you’re experiencing a difficult financial period, deferment and forbearance allow you to pause your loan payments, though interest may continue to accrue.

These repayment benefits set federal student loans apart from private student loans. That said, a federal student loan may be the right choice if you want access to these benefits.

Types of federal student loans

Several federal student loan options are available. You may have one or more types of loans depending on how much you need to borrow and your circumstances. The most common types of federal student loans are Direct Subsidized, Direct Unsubsidized, PLUS, and Direct Consolidation loans. 

Type of federal loan	Who can get it	Description
Direct Subsidized Loans	Undergraduate students with demonstrated financial need	The federal government pays the interest on the loan while you’re in school (at least half-time enrollment), during the six-month grace period after you leave school, and during periods of deferment or forbearance.
Direct Unsubsidized Loans	Undergraduate, graduate, and professional students	These student loans aren’t need-based. Interest always accrues on these loans.
Direct PLUS Loans	Parents of undergraduate students, graduate students, and professional students	Eligibility is not based on financial need. Unlike other types of federal student loans, a credit check is required.
Direct Consolidation Loans	Anyone with eligible federal student loans	These loans let you combine multiple eligible federal loans into a single loan with one loan servicer.

>> Read more: What’s the Difference Between Subsidized and Unsubsidized Student Loans?

When choosing between Parent PLUS loans and student loans, I believe the student should have some “skin in the game” by taking a loan. If that is insufficient to cover the costs, then the parent(s) can take out a Parent Plus loan.

Jim McCarthy

CFP®

How private student loans work

Federal loans have many benefits, but they don’t always cover the total cost of attendance. Some students also use private student loans to make up the difference. In fact, a recent report revealed that about 7.30% of outstanding student loan debt was from private loans.

Banks, credit unions, and other private organizations issue private student loans. They don’t offer the same borrower protections as federal loans, such as income-driven repayment plans and Public Service Loan Forgiveness. Plus, the lender determines interest rates.

Read More

Can I transfer a private student loan to a federal loan?

How to get a private loan

You can apply for private loans on any given lender’s website. To determine whether you’re eligible, the lender checks your credit history. If you don’t have good credit, you’ll need to apply with a cosigner, who will also undergo a credit check.

If you qualify, you may borrow up to the maximum loan amount based on your school’s certified cost of attendance, less other aid you’ve received (e.g., federal student loans, grants, or scholarships). 

Like federal loans, funds are often disbursed to your school, and you can use any remaining money to pay related costs. Repayment typically begins six months after graduation or if you fall below half-time attendance. Interest will accrue while you’re in school.

Monthly payments are determined by your rate and loan term rather than the income-driven repayment plans offered by federal loans. Depending on the lender, you may be able to put your payments on hold if you face financial hardship, but interest will continue to accrue.

What are the benefits of private student loans?

Private student loans have fewer benefits than federal loans. The top advantage is that they provide funding when federal loans aren’t enough to pay for the cost of school.

Other benefits of private student loans include:

• Potential to get a lower rate: Eligibility is based on your creditworthiness. If you have excellent credit, you may qualify for a lower rate on your private loan. However, your loan may have a higher interest rate if you don’t have good credit. Your credit doesn’t affect the rate on a federal loan. 
• Cosigners can help: If you can’t qualify for a loan alone or want a better interest rate, many lenders allow you to add a creditworthy cosigner to help you qualify and get a better loan rate.
• Fixed and variable interest rates: Depending on the lender, you can choose between fixed and variable rates. Variable rates typically start lower, although they could cost you more over time.
• High loan limits: You can often borrow up to 100% of the school’s certified cost of attendance, less other aid. This is helpful when federal loans aren’t enough to cover the money you need to attend school.

Ask the expert

Jim McCarthy

CFP®

If federal student loans don’t cover the cost of education, and the student is going to “pay their own way,” then private loans are really the only other option. If the family is going to cover the education costs, then the parents could consider looking at using their assets rather than private loans. Cash value life insurance, 401(k) loans, and withdrawing contributions from Roth IRA are possibilities, as is a home equity loan.

Federal student loans vs. private: What should I do next?

If you think you’ll need to take out student loans to help you cover the cost of college, complete the FAFSA form and apply for federal loans first. Once you know what you can borrow with your federal loans, you can decide whether to borrow more to attend school. 

If you need to borrow additional money from a private lender, compare rates from several lenders to get prequalified quotes before choosing one. The guides below can help you pick the right lender for you and your circumstances.

• How to apply for student loans
• Federal student loans guide
• Best private student loans
• Parent PLUS loans vs. private student loans