Federal Student Loans

Federal Student Loans- The Best Option

Federal student loans are without question the best option if you must take on debt to finance higher education. These loans are of course backed and guaranteed by the U.S. government. In general, students should avoid private student loans like the plague and should only take on this type of debt in certain circumstances. This will be explained below.

Lower Interest Rates

The interest rates on federal loans

are set by law and will be lower than interest rates on private student loans. As crazy as it may sound, many borrowers are so anxious to get a loan and get started in school that they sign up for private student loans and are surprised to learn that they have high interest rates, 13-18% is not unusual. In other words they don’t really know what interest rate they have signed up for. Federal student loans on the other hand have interest rates that are much lower, well below 10%.

Borrowers Rights With Federal Student Loans

Federal student loans offer borrowers many rights that private loans do not. In some cases federal loans are subsidized which means that the interest on the loan is paid by the federal government while the borrower is enrolled in school. Private loans will not have this feature, and interest will start to accumulate as soon as the loan is taken out. Federal loans also have provisions for mandatory deferment or forbearance if the borrower gets into financial difficulty sometime during the repayment period of the loan. It is likely that most borrowers will face some sort of financial problems during the long payoff period of student loans which can range anywhere from 10-30 years. Private loans might offer some sort of deferment, but the terms are up to the lender. Be very careful if you do defer a private student loan. You may find out that your interest rate is much higher after the deferment period. This will not be the case with a federal student loan. With federal student loans there are some provisions for cancelling the loan. This can occur if the student dies, if the college closes, or if the student borrower experiences a complete and permanent disability. Private loans have no such provisions, and the loan must be paid off even under those conditions. Federal student loans also have mandatory provisions for loan consolidation, and this is not the case for private student loans. A borrower might assume that he or she will consolidate their loans after graduation to obtain lower monthly payments. With private loans, however, the lender may simply refuse to consolidate, and the borrower is stuck with high payments on several loans.

When Should You Consider a Private Student Loan?

It would be advisable to never take out a private student loan. If you cannot get enough financial assistance from federal student loans and other sources of funds, it would be best to consider another school that costs less or working and saving money until you have enough to pay for college. If, however, you feel you must take out a private loan, only do this if the amount you are going to borrow is less than or at most equal to your starting salary. Also, make sure your payments will only amount to 10% or less or your gross income. If you go beyond those limits you are at risk to eventually defaulting on your private student loans, and this is something you should avoid at all cost. Borrowers who default on student loans are often surprised to find that they have been assessed huge penalties for having defaulted, including penalties of about 25% of the total amount borrowed and accrued interest just for loan collection. It is not unusual for borrowers who default to learn that they now owe 3-4 times the original amount borrowed and subsequently become overwhelmed by the debt on their student loans. It is much easier to avoid this kind of trap if you stay away form private student loans and stick with federal student loans if you must go into debt to finance college.