The debate regarding private versus Federal student loans is sometimes a misunderstood one. Read on for an explanation of the primary similarities and differences as part of an in-depth comparison of the two education financing choices.
Why is there a large expansion of private student loans?
Private student loans are becoming more popular in recent years. Actually, their growth has widely outpaced the expansion of Federal education loans. Recently growing at an annual rate of 25% compared to an 8% growth rate for Federal student loans, private financing is becoming much more significant for students.
One reason is the continuing increase in tuition, room and board, textbooks, and other fees being charged by all institutions of higher learning. As students reach their maximum borrowing limit for Federal student loans, they are beginning to look at private education financing differently.
Another reason fueling this trend is the many newer choices offered by an expanding universe of private education lenders. Not long ago, there were relatively few private student loan companies and the variety of financing options was minimal. In recent years, however, there have been numerous well-financed, new private student loan companies and this competition has created better terms for borrowers.
Federal student loan choices
The two primary federal student loan choices are the Stafford and the Direct PLUS programs. Stafford education financing may involve subsidized and unsubsidized student loans. Those in the subsidized category are based on financial need and have their accrued interest paid by the Federal government while the borrower is at least a half-time student.
Unsubsidized student loans are available regardless of your financial situation, but the accrued interest prior to your graduation will be added to your loan balance when you set up your repayment plan.
Another feature of Federal student loans is the potential forgiveness provision that will cancel some or all of your outstanding balance if you become, for example, a teacher or childcare provider. There may be other eligible categories based on the wishes and legislation created by the Federal government. Always examine the choices on an annual basis as Congress may enact new legislation making some opportunities for cancellation available.
The Federal Perkins Loan program is a campus-based student financing product administered by your college or university. Funding comes from the Federal government, but loans are made to students judged worthy by the administration of the university.
Why private student loans are more expensive than federal financing
Private student loans are typically more expensive, with higher interest rates and a menu of administrative fees. There are simple reasons for this: supply, demand, and capitalism. Private student lenders are in business just as are banks, credit unions, and mortgage lenders, to lend funds, make income, and - hopefully - profit.
Private student lenders receive no government or non-profit related grants, loans, or other funds. They must generate their own lendable funds, which always come at some cost, however modest. They must then make private student loans that are low interest, but generate sufficient income to pay for operating expenses and leave something for profit.
The expansion of the student lending market, however, has brought much more competition to this industry. This is good news to student and parent borrowers. Competition in an open market, particularly if the demand for the product (in this case, student loans) is strong, typically results in lower prices.
As you might expect, there are currently no provisions that allow loan forgiveness or the variety of repayment terms offered by Federal loans. Yet, interest rates, while normally higher than Federal student loans, are still reasonable. When you need more financing to keep your college or university happy, private student loans serve their purpose very well.
Situations when private student loans are the best option
Although private student loans are an effective secondary source of education financing, some situations evolve into best choice options. If you've reached your maximum Federal loan limit, have exhausted other low cost – or even no cost – avenues, like Pell Grants (which do not have to be repaid), private student loans can quickly become a "best choice" solution.
When you need that final "piece of the puzzle" for education financing, private student loans, offered by reputable companies at reasonable rates and terms, often become a good solution.
Most private student loan rates are tied to the LIBOR (London Interbank Offered Rate), as are many adjustable rate mortgages, or even to the Prime Rate in the U.S., with some percentage added to one of these rates. With repayment terms up to 20 to 25 years, private student loans can still provide the financing you need and give you the opportunity to repay comfortably as you commence your professional career.
