Parents funded 31% of college costs for their children in the 2016 to 2017 school year, according to Sallie Mae’s comprehensive look at How America Pays for College. While most of this cash came from savings, parents borrowed money to pay around 8% of costs associated with college for their kids.
Parents who are taking out loans for a child’s college education, or who are helping their children borrow money, need to understand the different types of loans available. In particular, it’s important for parents to understand the differences between private student loans and federal loans for college.
This guide will help parents find out the answers they need, including answering questions such as what is a private student loan and when should students and parents take out private loans for college.
What is a private student loan?
Understanding the definition of private loans is the first key step when deciding how to borrow for school.
A private student loan is a loan offered by financial institutions including banks, credit unions, and online lenders such as Sallie Mae, Citizens Bank or LendKey.
Private student loans are distinct from a federal student loan, which must be offered through the Department of Education. Private student loans do not have the advantages federal loans have. As the Department of Education explains, some of the key differences between private and federal loans include the following:
Many private loans require repayment while students are in school. When students take out federal loans, repayment doesn’t begin until after graduation or until a student is no longer attending school at least half the time.
Federal loans have fixed interest rates. Private student loans might have variable interest rates, which means interest and payments can fluctuate up or down.
While private student loan interest rates vary based on your creditworthiness and other factors, the interest rate for federal loans is often lower than the interest rate for private loans.
Undergraduate students might be eligible for subsidized student loans, which means the government pays interest costs as long as the student is going to school at least half the time. There are no subsidized private loans.
Most federal student loans, except for PLUS Loans, don’t require a credit check. Private student loans require a credit check and students and parents could be denied loans for bad credit. Credit also impacts loan rates for private loans, but does not impact loan rates for federal loans.
Students do not need cosigners for federal loans, but typically require cosigners for private loans.
Federal loans can be consolidated into a Direct Consolidation Loan, but private student loans cannot.
Federal loans offer forbearance and deferment, while most private loans provide limited or no help to students facing financial difficulties.
Federal loans offer more flexibility in repayment than most private loans, including options for income-driven repayment plans.
Federal loans have origination fees of 1.066% for Direct Subsidized Loans and Direct Unsubsidized Loans and 4.264% for PLUS Loans for loans distributed on or after Oct. 1, 2017, and before Oct. 1, 2018. Origination fees for private loans vary by lender.
Loan forgiveness is possible for qualified borrowers with federal loans who work in public service, but private lenders don’t offer loan forgiveness.
Private loans do serve an important purpose. If students have exhausted limits on the amount of federal funding they can receive, either parents or students might take out private loans to pay for any additional costs of attending an academic program.
Are private loans for college the best choice?
Because of the significant benefits of federal student loans, students should exhaust all federal loans before considering private loans. Even if parents want to help children pay for college, if they must borrow money to do it, students should take out federal loans first. Parents can simply repay the federal loans their children have taken out if they want to help them.
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