What's the Difference Between Private and Federal Student Loans?

There are some big differences between federal student loans and private student loans, especially when it comes to interest rates and repayment options.

For most student loan borrowers, federal student loans are a better choice than private student loans. Rates are lower and repayment is more flexible. Students should use federal student loans to the extent they are available, and consider private loans only when federal aid isn’t enough to pay for your education. This article explains the most important differences between federal and private student loans.

(For more articles on student loans, see our  Student Loan Debt  topic area.)

What Is a Federal Student Loan?

Federal student loans are loans made for post-secondary education issued or guaranteed by a federal agency. The federal Department of Education controls most federal student loans. The federal Department of Health and Human Services controls specialized federal loans for  students in health professions. (You can learn more about health profession loans on the website of the Health Resources and Services Administration at  www.hrsa.gov; click on "Loans & Scholarships.")

In the past, the federal government offered some loan programs in which private lenders issued the loans but the federal government guaranteed that the loans would be repaid. Since July 2010, all federal student loans are issued by the federal government. Current federal student loan programs with the Department of Education include Direct Loans, Direct PLUS Loans (for parents or graduate students), and Perkins Loans.

What Is a Private Student Loan?

A private student loan is a loan made by a bank or credit union to pay for the costs of post-secondary education. In addition, some states have student loan programs for state residents.

Lower Interest Rates for Federal Loans

Interest rates are almost always lower for federal student loans than for private student loans. It is important to know the difference between fixed interest rates and variable interest rates. A variable interest rate may be low right now but will rise as interest rates rise. A fixed rate stays the same through the life of your loan.

For 2013, fixed interest rates for federal Stafford loans were 3.4%. A private lender may offer a lower rate, but only with a variable interest rate loan. A fixed interest rate loan from a private lender will have a higher rate than a federal loan. In addition, a private lender will usually require a co-signer on your loan to get the best rate. A co-signer is person who is obligated to pay back your loan if you are unable to do so.

More Repayment Options for Federal Loans

Federal lenders offer many repayment options that take your income and circumstances into account. Options include:

• Deferment (you postpone payments for a period of time and interest does not accrue)

• Forbearance (you postpone payments for a period of time and interest does accrue)

• Cancellation/Discharge (part or all of your loan balance is forgiven)

• Income-Contingent Repayment

• Income-Based Repayment

To learn more about postponing payments, see Nolo's article  Student Loans: Cancellation, Deferment, and Forbearance. To learn more about repayment plans, see Nolo’s article  Student Loan Repayment Options.

Private lenders are not required to, and usually don’t, offer different repayment options based on your circumstances. Your loan agreement will contain alternative options, if any. Some private lenders have created programs for distressed student borrowers. For example, Wells Fargo and Discover Bank have offered limited cancellation programs for borrowers who die or become permanently and totally disabled. Review your loan agreement and research your private lender’s policies to determine if you are eligible for any repayment options.

One important circumstance to consider is whether you plan to attend graduate school after an undergraduate degree. Federal student loans are deferred during your graduate studies. Private student loans usually are not deferred, so you will be required to continue making payments while you’re in school.

Collection of Defaulted Student Loans

If you default on your student loans, the lender will pursue collection. Federal lenders do have more collection options available than private lenders. However, this is a limited disadvantage to federal student loans that does not outweigh the interest rate and flexible repayment advantages of federal loans.

Private Lenders Must Get a Judgment

When you take out any loan you will sign a promissory note. All that a federal lender needs to enforce your loan in court is that signed promissory note. Based on the note, a federal lender can file in court to garnish your wages or bank account.

A private lender cannot garnish your wages or accounts just based upon a promissory note. A private lender must first file a lawsuit against you in court for a money judgment. If the lender gets a judgment, it can garnish your wages or bank account, among other things. To learn more about how private student loan lenders can collect defaulted loans, see  Collection Methods Used by Private Student Loan Lenders.

Federal Lenders Can Seize Your Tax Refund or Social Security Benefits

A federal lender can take benefits that come from other federal agencies. For example, a federal lender can seize your federal income tax refund from the IRS. A federal lender can also seize part of your social security benefits. Private lenders do not have the power to seize federal payments and benefits.

Discharge in Bankruptcy

Neither federal nor private student loans are easily discharged in bankruptcy. To discharge any student loan in bankruptcy, the borrower must show that repayment poses an “undue hardship.” Bankruptcy courts have found “undue hardships” only for the most financially distressed borrowers—those who have no chance of ever increasing their income. To learn more, see  Student Loan Debt in Bankruptcy.

Statutes of Limitations

One important difference between federal student loans and private student loans is that private student loans are subject to statutes of limitations. Statutes of limitations set forth deadlines for filing in court for a money judgment. The time periods vary by state and can be anything from three to fifteen years. If you have been in default on a private student loan for several years, consult an attorney to determine whether the statute of limitations has run on your debt.

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