College Loans: Private vs. Federal

Paying for college is a top financial priority for many people, but the ever-increasing cost for higher education is beyond many people's financial reach. When you don't have savings or investments to cover the cost of your children's college education, you may need to investigate loan options.

Federal college loans are loans the federal government funds to help students or parents pay for the cost of a college education.

To qualify for a federal loan, you will need to complete and submit a free application of student aid (FAFSA) form to the U.S. Department of Education. The Department of Education uses the FAFSA form to determine your expected family contribution (EFC), or how much your family will be required to pay towards the college bill. Your school's financial aid office can help explain the FAFSA form and the different types of federal loans you or your student may qualify for. To use a federal loan to pay for your education, you must be enrolled in a program offered by an accredited school.

There are five types of federal student loans:

The Perkins Loan is a need-based loan for applicants with little income and few assets. The college is the lender so eligibility depends on the student’s need and the availability of funds at the college. Schools help to determine a student's financial need and how much money will be awarded to each applicant. It can be a helpful financial tool for needy students and offers several benefits, including:

• A low, fixed rate of interest 
• Potential loan cancellation for borrowers who go into certain service professions upon graduation, such as the military or teaching 
• No loan fees 
• A longer grace period before repayment is required 

Borrowers must be U.S. citizens, permanent residents or be eligible for non-citizen status, be enrolled at least half-time in a degree program, and maintain acceptable academic standards. Funds will be sent to the student or applied directly to tuition. (For related reading, see: Last Minute Strategies to Help Pay for College.)

The Federal Direct Loan program is the largest and best known of all federal student loan programs. There are four types of federal direct loans:

• Direct Subsidized Loan
• Direct Unsubsidized Loan
• Direct PLUS Loan
• Direct Consolidation Loan

Direct Subsidized Loans are need-based, meaning applicants must demonstrate financial need, which is determined by subtracting your expected family contribution and other sources of financial aid from the cost of your college education. The loans are called subsidized because the government subsidizes the interest on the loan while you are enrolled at least half-time. You are not charged interest on your loan until you graduate, and you have a six-month grace period after leaving school before you need to begin making payments on the loan. If your loan is deferred, you will not be charged interest during that period of time. (For related reading, see: Student Loan Deferment: Live To Pay Another Day.)

Direct Unsubsidized Loans are not given on the basis of financial need. Interest charged on the loan amount begins accruing when you receive the funds and continues until it is repaid in full.

Students applying independently for a Direct Loan (as opposed to a parent applying for funds on a dependent child's behalf) have a higher annual loan limit and can qualify for a higher amount of unsubsidized funds.

There are several attractive benefits to Direct Loans, including:

• no need to pass a credit check
• a low, fixed-rate of interest
• several flexible repayment plans
• no penalty for prepaying the loan

However, there are factors to consider before applying for funds, including:

• Low loan limits
• Requirement to file a FAFSA form
• Requirement to apply for funds each academic year
• Limits on how you can use funds
• Student must remain enrolled at least half-time to qualify for and continue receiving funds
• Small loan fee

Direct PLUS Loans are designed for parents of college students and are not based on financial need. The PLUS Loan offers parents several attractive loan features including that applicants can borrow the full cost of college (minus any financial aid or scholarships earned), it carries a low, fixed rate of interest (but higher than that for other Direct Loan types) and it offers flexible repayment plans, such as the ability to defer payment until the student graduates or drops below part-time enrollment status. However, the PLUS Loan does require parent applicants to pass a credit check (or obtain a cosigner or endorser) and apply for funds each academic year.

Direct Consolidation Loans help you repay your federal student loan debt. (For related reading, see: Time to Consolidate Your Student Loans?)

Private loans are those you can obtain from banks, credit unions or other lending institutions to help cover college expenses not met by scholarships, grants, federal loans or other types of financial assistance. Most private loans are made directly to students, meaning it becomes their financial and legal responsibility to repay the loan.

You can apply for a private loan at any time and use the loan proceeds toward any college expenses, including tuition, room and board, books, computers, or transportation.

There are several reasons why private loans are attractive college financing options:

• Easy application process (typically you can apply for a loan online or by phone)
• Most loans do not require you to complete a FAFSA form for federal aid
• Loan funds are made available immediately upon approval
• Cosigner options are generally available
• Interest on a private loan may be tax-deductible
• Most loans do not include a prepayment penalty and charge low, if any, fees

There are a few potential downsides to consider before applying for a private loan for college. Most lenders will require you to pass a credit check. However, if you do not have a sufficient credit history to qualify for the loan you may be able to get a cosigner. Also, private loans typically charge a higher interest rate than federal loans, so the size of the loan can have some bearing on your choice in lender. Finally, funding must be applied for every academic year—just because you're approved this year is no indication of your loan status for next year.

Because private lenders typically charge a higher interest rate, it's a good idea to explore other, less expensive forms of financing first, such as grants, scholarships, work-study programs and federal loans. College payments are a substantial investment into the future of an individual. Schooling decisions go beyond just the financial numbers and move into the territory of bettering one's self. Even so, finances cannot be ignored. Exploring your options can save headaches and money now and in the future. (For related reading, see: Pay For College Without Selling a Kidney.)