How and When to Use Federal and Private Student Loans
College comes with a lot of new expenses that many students encounter for the first time. While your financial aid may cover tuition and books, how will you fill in the other expenses of daily life? Should you use part of your student loans for living expenses?
Other options include private loans versus parent plus loans. You should leverage scholarships, part time work, and help from your family first. Even after this, you’ll still need to know how and when it’s time to use your loans to fill the gaps.
Types of Loans Used for College Expenses
A good rule of thumb, is to borrow first from federal loans when you’re funding college tuition. There are different types of federal loans, some of which are better than others for your needs:
- Direct Subsidized Loans
These types of loans offer the most value for borrowers. They offer fixed interest rates throughout the life of the loan. This type of loan doesn’t start accruing interest until six month after you leave school.
The only catch, is that these types of loans are only possible for students who can show a financial need. There are also annual and lifetime limits that you can take out.
- Direct Unsubsidized Loans
The other option is an unsubsidized loan. The downside here is that interest starts building up immediately, even if you’re still in school. They still have the same low and fixed interest rate, but there’s no grace period.
The interest rates will also be much higher if you’re in graduate school. The rate after July 1st, 2017 was 6.00 percent.
- PLUS Loans
This type of loan is great for students who need to finance their other expenses during college. This is available at either the undergraduate or graduate levels. It’s great, because you can take out all the PLUS loans that you’ll need to cover costs. Of course, there’s a price to pay.
For starters, the interest rates on PLUS loans are on the way up. Rates issued between July 2017 and June 2018 are 7.0 percent. These types of loans also have a 4.3 percent up-front disbursement fee.
PLUS loans are risky because they have the highest interest rates. They also have the least amount of repayment options. Unlike private loans, the government does not run a thorough credit check on these types of loans. They only run a basic check.
This is a plus for those who need a loan for expenses. Applications aren’t denied unless you have a rough credit history. This includes late payments, foreclosures, or bankruptcy. It’s a double-edged sword, because the ease of obtaining these loans means it’s easy to lose control.
Federal Loans vs. Private Loans
Students with little income or credit history will need a cosigner. The federal government calls them an “endorser.” This person will agree to take on the responsibility of the loan if you cannot make payments.
In some cases, this is only temporary. Many lenders out there will eventually remove the cosigner from the loan. This is after the borrower has established a history of timely payments. When you take out one of the federal loan types, the interest rate is set for the duration of the loan.
The difference with private loans, is that borrowers can shop around for the best rates. Fixed and variable rate options are available with varying interest rates. This is a far different story than federal loans which offer the same rate to everyone.
The final interest rate on private loans depends on several different factors:
- Your credit score and history
- The presence of a cosigner
- The cosigner’s credit history
- Your choice between fixed and variable rate loans
A variable rate private loan can offer a lower initial interest rate. You may also have lower monthly payments. As time goes on, the rate may increase, along with the payments. These loans are ideal for those who plan to pay it off quickly.
Borrowers who prefer stability can opt for a fixed-rate loan. These loans will keep your interest rate fixed in place. One downside to private loans is that they don’t offer the same benefits that federal loans have.
Income-driven repayment (IDR) plans won’t be available with many private loans. There won’t be access to loan forgiveness with private loans either. Anything that stretches out the repayment term of a loan will add to the interest and total amount paid.
Some private loan companies will offer their own repayment plans:
- Immediate payment (start paying while you’re in school)
- Interest Repayment (only pay interest while you’re still in school)
- Partial interest (you make a flat payment while in school that covers a portion of interest)
- Full deferment (you don’t pay anything while you’re in school, but the balance grows with interest)
Using Private Loans to Cover College Expenses
If you decide to choose private loans for your expenses, be sure to shop around for the best rates. Private lenders offer different types of loans and a variety of rates. These are unique to the lender and the borrower.
You can also find discounts for borrowers who agree to have automatic payments. You should be on the lookout for offers like this as well. Finally, see if you can find a reliable cosigner. It can be a parent, legal guardian, friend, or even an employer.
When it comes down to it, college is expensive. Expenses go beyond tuition, so look for the best loan option. Which type of loan do you prefer for college expenses? Let us know in the comments!
About the Author: Stephen Dash is the Founder and CEO of Credible. He founded Credible because of sheer disbelief at the burden student debt placed on young Americans (a problem that does not exist in his native Australia). Stephen was formerly an investment banker at J.P. Morgan, and more recently founded QC Media and was an Investment Director at MHC & Co.
*Views expressed are the personal views of the author, and do not necessarily represent the views of the National Foundation for Credit Counseling, its employees, its members, or its clients.
