Student Loan Insurance: Private Vs. Federal Loans

Private student loans are not federally insured. They are offered by private institutions such as banks, credit unions, and online lenders. In contrast, federal student loans are provided by the government and are either subsidized or unsubsidized. While federal loans generally offer more favourable terms, private student loans can be a good option for those who have already borrowed the maximum amount of federal loans or have good credit scores.

Federal vs. private student loans: Who owns the debt?

Federal student loans are provided by the government, while private student loans are provided by banks, credit unions, and other financial institutions. Both types of loans must be paid back with interest, regardless of whether the borrower graduates or not.

Federal Student Loans

The US Department of Education administers federal student loans, which are available to students with "exceptional financial need". There are two types of federal loans: subsidized and unsubsidized. The government subsidises the interest on subsidised loans while the student is enrolled at least half-time. Students with subsidised loans are also given a six-month grace period after leaving school before they need to start making loan payments. Unsubsidised loans are available to students regardless of financial need.

Private Student Loans

Private student loans are not based on a borrower's financial needs and usually require a credit check to prove creditworthiness. Private loans can come with higher borrowing limits than federal loans, and the repayment period may differ. While some lenders may allow borrowers to defer payments until after graduation, others might require repayment while the borrower is still in school.

Who Owns the Debt?

The federally guaranteed student loan program ended on 30 June 2010. However, many people are still paying off guaranteed loans issued before this date. Under the guaranteed student loan program, if a borrower defaults on a guaranteed loan, the federal government pays the bank and takes over the loan. The government then owns the loan and the right to collect payments.

Since 2010, all federally guaranteed student loans have been processed and disbursed directly through the US Department of Education.

Federal loans: What are the pros and cons?

Federal loans are issued directly by the federal government to students. They are distinct from private student loans, which are not guaranteed by the government. Here are some pros and cons of federal loans:

Pros

• Federal loans are more flexible than private loans, offering income-driven repayment plans, deferment and forbearance, and various student loan forgiveness programs.
• Federal loans are available to all students regardless of financial need or credit history.
• Federal loans often have more attractive interest rates than private loans. For example, the Federal Direct Subsidized Loan has an interest rate of 3.4%, while the Federal Direct Unsubsidized Loan has an interest rate of 7.6%.
• Federal loans require no collateral for approval.
• Federal loans can be consolidated, making repayment more manageable.
• Federal loans offer a fixed interest rate for the total life of the loan.
• Federal loans allow students to start building their credit history.

Cons

• Federal loans have a limit, and once a student reaches that limit, they will need to consider additional ways to cover their expenses.
• The application process for federal loans can be lengthy and complicated.
• Federal loans may have fewer repayment term options than private loans.
• Federal loans may take longer to pay off than private loans, which could hinder opportunities to make large purchases or investments in the future.
• Federal loan forgiveness programs may be difficult to qualify for and are currently facing legal challenges.

Private loans: What are the pros and cons?

Private student loans are issued by private lenders such as banks, credit unions, and other financial institutions. They are distinct from federally guaranteed student loans, which were discontinued in 2010. Private student loans can be a viable option if you've exhausted your allotment of federal loans and other free funding sources. Here are some pros and cons of private student loans:

Pros:

• Private student loans can provide additional funds for college expenses beyond what is covered by scholarships, grants, and federal financial aid.
• Borrowers with excellent credit can potentially obtain more favorable rates with private student loans.
• They offer either fixed or variable interest rates and higher borrowing limits as long as you don't exceed the cost of attendance (less other financial aid).
• Private student loans have a faster application process than federal loans.
• Private student loans are open to those who don't qualify for federal student loans, such as students who do not demonstrate financial need, aren't enrolled at least half-time, or have exceeded the maximum federal borrowing limit.
• Up to $2,500 in private student loan interest each year may be tax-deductible.

Cons:

• You need to have good to excellent credit to qualify for a loan, or the lender may require a co-signer.
• Private student loans have fewer repayment and forgiveness options than federal student loans.
• Interest rates are based on creditworthiness. Unless your income and credit score are stellar, you may end up with a much higher rate than you want.
• Private student loans generally cannot be discharged when a borrower files for bankruptcy.
• Deferment and forbearance options are not guaranteed with private student loans and are typically more limited than with federal loans.
• You could access a private student loan equivalent to your total cost of attendance (minus other financial aid), but you risk borrowing more than you need and getting stuck with steep monthly loan payments and hefty interest.
• When you die, your federal student loans are discharged, but this isn't always the case with private student loans. Some lenders may try to recoup the debt from your estate, negatively impacting the inheritance left to your loved ones.

Federal loans: How to apply

Federal loans are provided by the U.S. government to eligible students or their parents/guardians to help cover the cost of higher education. They are a dependable option for financing education as they are distributed directly from the government.

How to Apply for Federal Loans

To apply for a federal loan, you'll need to submit a Free Application for Federal Student Aid (FAFSA). The FAFSA is used by two-year and four-year colleges, universities, and career schools to award federal, state, and college-funded student aid. It is the first step in the financial aid process and is completely free to submit.

You can fill out the FAFSA online, which is the fastest and easiest way, and your application will be processed within 3-5 days. Alternatively, you can mail in a paper application, but this will take longer (7-10 days). Remember, you should never have to pay to submit the FAFSA.

The FAFSA will determine your eligibility for federal student loans, as well as other federal student aid such as grants and work-study. You will need to submit the FAFSA every year you are enrolled in college to continue receiving federal student aid.

After submitting the FAFSA, the government will send you a FAFSA Submission Summary, which outlines basic information about your eligibility for federal student aid. The colleges you included on your FAFSA will use this information to determine the amount of federal student loans, grants, and work-study you may qualify for.

Once you are accepted to a college, you will receive a financial aid offer detailing the financial aid you are eligible to receive, including federal student loans, grants, and work-study. The amount of federal aid offered will vary depending on the school.

Eligibility Requirements

To be eligible for federal student loans, you must meet the following requirements:

• Be a U.S. citizen or eligible non-citizen
• Have a valid Social Security Number (unless you are from the Republic of the Marshall Islands, the Federated States of Micronesia, or the Republic of Palau)
• Register with Selective Service if you are a male aged 18 to 25
• Have a high school diploma, a General Education Development (GED) Certificate, or pass an exam approved by the U.S. Department of Education
• Be enrolled or accepted for enrollment as a regular student working toward a degree or certificate in an eligible program at a school that participates in the federal student aid programs
• Not have a drug conviction for an offense that occurred while receiving federal student aid

Types of Federal Student Loans

There are several types of federal student loans available through the Federal Direct Loan Program:

• Direct Subsidized Loans: Available to undergraduate students with demonstrated financial need. There is no interest charged while the student is in school at least half-time, during deferment, or during the grace period.
• Direct Unsubsidized Loans: Available to undergraduate and graduate or professional degree students regardless of financial need. Interest is charged during all periods and may be capitalized, increasing the total federal loan cost.
• Direct PLUS Loans: These include Grad PLUS Loans for graduate and professional students, as well as Parent PLUS Loans issued to the parents of dependent undergraduate students. PLUS loans can help cover education expenses up to the cost of attendance after other financial aid is exhausted. A credit check is required, and borrowers with adverse credit history must meet additional requirements. Interest is charged during all periods and may be capitalized.

Private loans: How to apply

Private student loans are typically issued by banks or financial institutions. They are based on your creditworthiness, and your cosigner's credit, if you have one.

Understand the requirements:

You must be at least 18 years old with a valid Social Security number and be a US citizen or resident. International students may still qualify with a cosigner who is a US citizen. You must also show you plan to attend an accredited college, university, or trade school.

Private student loans typically require a positive payment history and a minimum credit score in the upper 600s or higher. You might also have to meet a minimum income requirement.

Consider a cosigner:

If your credit history is minimal or below average, you might need a cosigner to qualify for a private student loan. Over 90% of undergraduate students needed a cosigner for private student loans in the 2022-2023 academic year. A cosigner reduces the risk for the lender and is responsible for repaying the loan if the borrower defaults.

Compare offers from multiple lenders:

It is important to shop around and compare interest rates, loan terms, and eligibility requirements to find the best loan for your needs. Look at the stability of jobs in the industry you're studying when comparing different offers. Consider the repayment, forbearance, and cosigner release terms of each loan.

Submit an application:

Once you've identified the private student loan offer that best fits your needs, fill out an online application. You will need to submit documents and information, including your Social Security number, a list of potential schools with contact details, and proof of income (W-2s, tax returns).

Receive approval:

After your application is approved, the lender will send the funds directly to your school. The school will apply the money to your tuition and other necessary fees, and any remaining funds will be disbursed to you.

Remember, it is essential to explore federal student aid options first, such as grants, scholarships, and federal loans, as these offer unique benefits like income-driven repayment plans. Private student loans are best used to bridge the gap when federal aid is not enough to cover all your college-related expenses.

Frequently asked questions