Choosing Between Federal and Private Student Loans

Picking a student loan that meets your needs requires an understanding of some basic concepts. Student Loan Basics empowers you with information to make informed choices to borrow for college. This article explains the difference between undergraduate federal and private loans.

Federal vs private student loans

The fundamental difference is the lender.

  • The federal government, specifically, the U. S. Department of Education, is the lender for all federal student loans
  • Private loans are made by others: banks, credit unions, credit card companies, colleges and universities, agencies created by states, specialty finance companies, etc.

In 1965, Congress passed the Higher Education Act to loan federal money to students. The goal was to provide access to higher education to any student who wanted to go to college - regardless of income or assets. Over time, a separate program was established for parents to help their children.

Private loan programs were created to supplement the federal program for students who needed more money than the government would lend them. Some families skip the federal loan program and take private loans to avoid filing the paperwork necessary to get a federal loan.

The Federal Student Loan Programs

The U.S. Department of Education (DoE) loans money to families under the William D. Ford Federal Direct Loan Program (a.k.a. Direct Loans). There are four Direct Loan types:

  • Subsidized: for students
  • Unsubsidized: for students
  • PLUS: for parents
  • Consolidation: for students or parents

To be eligible for a Direct Loan, borrowers must file a FAFSA form (“Free Application for Federal Student Aid”) after October 1st for the academic year that begins the following year. Students seeking a federal loan for the academic year 2021-22, which begins in the summer of 2021, need to file the FAFSA form after October 1, 2020.

Subsidized vs. Unsubsidized Direct Loans

The DoE uses the FAFSA form to capture information about the family and the student to determine a student's eligibility for a Direct Subsidized Loan. Subsidized loans are need-based and relieve students from the responsibility for the interest that accumulates during the in-school, grace, and deferment periods.

Unsubsidized loans require students to either pay the interest during those periods or to capitalize the interest. Students who capitalized interest choose not to pay the interest due on the loan. Instead, they elect to add that amount of unpaid interest to the principal amount of the original loan.

  • 1st Year Students $5,500
  • 2nd Year Students $6,500
  • 3rd and 4th Year Students $7,500/year

Loan Terms and Conditions

The process for applying for a Direct Loan starts with filing the FAFSA. The DoE then provides information to the college, which offers student aid, including Direct Loans, via a Financial Aid Award Letter. The Financial Aid Award letter will detail a student's eligibility for Direct Subsidized and Direct Unsubsidized loans.

Direct Loans:

Student loans, like other financial instruments, require borrowers to enter into a binding contract that discloses the requirements of the loan and outlines the borrower's responsibility to repay the loan. The DoE uses a Master Promissory Note (MPN) to obligate the borrower to repay the loan. Many colleges permit students to use one MPN for all four years of college.

Direct PLUS loans

Direct Plus Loans are made to parents of dependent undergraduate students (a.k.a. Parent Plus Loans) and to graduate and professional students (a.k.a. Grad PLUS Loans) Borrowers.

Unlike other Direct Loans, Parent Plus and Grad Plus Loans are credit tested. Borrowers cannot have an Adverse Credit History as defined by the DoE. Borrowers can be denied a Plus Loan for several reasons including a prior student loan default or having balances greater than $2,085 that are at least 90 days past due, among other knock-out criteria.

Like other Direct Loans, Direct Plus Loans:

  • Offer a fixed interest rate
  • Charge an Origination Fee
  • Have a cap on the amount that may be borrowed-The Parent Plus Loan cap amount is the college's cost of attendance.

Under the Parent Plus program, the parent is the sole borrower. Parents are unable to transfer the loan to the student in the future.

Private Credit Student Loans

Banks, credit unions, and others make Private Credit Loans to those who pass the lender's credit tests. These credit tests are often very similar to requirements lenders impose on borrowers for mortgages, personal loans and automobile loans.

Often, dependent undergraduate students do not have an established credit track record to pass a lender's credit test, but they may still get a Private Credit Loan. Nearly all Private Credit Loan lenders permit a co-signer to join the student as an obligor on a loan. In this way, the lenders consider the co-signer's history and may extend a loan to the student and cosigner.

Important note: Both the student and the creditworthy co-signer are contractually obligated under the terms of the loan. If a student is unable to make payments, the co-signer needs to make the payment or they, too, will be reported as delinquent to the credit bureaus.

Many lenders also offer a co-signer release feature that permits the non-student co-signer to be removed from the loan once a student meets tests established by the lender.

Private Credit Loans:

  • Require students to pass a credit test often requiring undergraduates to apply with a co-signer
  • May offer fixed or variable rate loans with an interest rate that is dependent on the creditworthy borrower's credit profile
  • Rarely charge an Origination Fee
  • Offer varying repayment periods, often between 5 and 20 years
  • Have a maximum borrowing amount equal to the cost of attendance


Undergraduate students have options to choose the best loan to help them pay for college. The Federal Direct Program is designed to give students a limited amount of money to pay for college at a fixed rate of interest with favorable repayment terms. Other lenders offer Private Credit student loans which may supplement or be a substitute for Federal Direct Loans.

Families should understand the terms and conditions for each loan option and choose the loan which offers an optimal combination of terms and conditions for the student or parent borrower. For most families, the Federal Direct Program offers the combination that works the best.

It's vital to understand the basics of student loans before you select one. As we like to say: know before you owe!