Student Loans: Federal vs. Private
April 28, 2009— The Project on Student Debt recently reported that the percentage of undergraduate college students who took out private (non-federal) student loans shot up from 5% in 2003-2004 to 14% in 2007-2008.
This large jump attracted the attention of college student advocates because private student loans typically have much higher interest rates and less favorable borrower terms than federal student loans. The first step to understanding federal vs. private student loans is to make sure you are fully informed about the federal student loan program and the billions of dollars it has to offer college students each year.
There's plenty of money for federal student loans
The first thing you should know is that there's plenty of federal money for student loans. During the 2007-2008 academic year, the federal government awarded approximately $100 billion in financial aid to nearly 10 million students enrolled in degree, voc/tech, and continuing education programs. That number is likely to be the same, or higher, with the dollars the Obama administration has just added to the education budget.
Federal student loans can be used for any Title IV-accredited education program
You don't need a private loan to pay for programs at for-profit schools. As long as the school and program you're enrolled in are both accredited by an accrediting agency recognized by the U.S. Department of Education and listed under Title IV of the U.S. Higher Education Act, you can use a federal student loan to pay for qualified education expenses. The school may be a public state university or community college, a private nonprofit university, college, or career education school, or a private for-profit college or career education school.
Federal Stafford Loans
The Stafford loan is the standard federal loan available to students pursuing undergraduate, graduate, or professional degrees, and voc/tech or career education. Campus and online programs accredited under Title IV may be funded with Stafford loans.
Stafford loans are provided in two versions, subsidized and unsubsidized. The Department of Education pays the interest on subsidized Stafford Loans during certain time periods, such as when the student is in school, whereas the student is responsible for paying the interest on an unsubsidized Stafford loan right from the start.
Unsubsidized Federal Stafford Loans: Available to nearly all students regardless of age or income
The subsidized Stafford loan is need-based; it is restricted to students under a certain income limit. But the unsubsidized Stafford loan is NOT based on financial need; almost all students qualify for an unsubsidized Stafford loan of some amount. In addition, there is no age restriction on Stafford loan eligibility.
In addition to a lower interest rate, the advantages of federal Stafford loans vs. private student loans include:
- a fixed interest rate vs. a variable rate,
- no credit check,
- more flexible repayment terms, and
- greater availability, especially in an economy when private financial institutions are pulling back on all their loans.
A fixed interest rate means the interest rate will stay the same for the duration of the loan. A variable rate means the interest rate will change over time; it could go down, but it could also go up.
Interest Rate Dropping on Subsidized Stafford Loan for Undergraduates
For undergraduate students only, the fixed interest rate on a subsidized Stafford loan will decrease each year over the next several years. For subsidized Stafford loans first paid out to undergraduate students between July 1, 2008 and July 1, 2009, the interest rate on the unpaid balance is 6.0%. Then:
- For loans paid out between July, 1, 2009 through June 30, 2010: 5.6%
- For loans paid out between July, 1, 2010 through June 30, 2011: 4.5%
- For loans paid out between July, 1, 2011 through June 30, 2012: 3.4%
Since July 1, 2006, new unsubsidized Stafford loans for both undergraduate and graduate students have carried a fixed interest rate of 6.8%.
Even at 6.8%, these interest rates are lower than the current interest rate of the average private loan, which is 12%, according to Mark Kantrowitz, publisher of FinAid.org. He and other financial aid advisers, while acknowledging the sometimes unavoidable necessity of private funding for high-tuition schools, urge higher education students to apply for scholarships and take out the maximum federal loan that they qualify for before seeking private loans. In 2007-2008, 25% of private loan borrowers did not take out any federal Stafford loan at all, subjecting themselves to far higher and less predictable interest rates, less favorable borrowing and repayment terms, and credit checks.
To get a federal Stafford loan, you need to fill out a FAFSA, or Free Application for Federal Student Aid, as soon as possible. Your FAFSA is also your Pell Grant application. If your FAFSA qualifies you for a Pell Grant, you will get one automatically.
Sources: Project on Student Debt; U.S. Department of Education; "Choosing Federal or Private Loans," David K. Randall, Forbes.com, 4/22/2009