Private Student Loans vs. Federal Student Loans and Your Alternatives
Unless you’re one of the 0.1% of people with the skills to grant you a full ride scholarship, college is expensive.
In the decade between the 2006–07 and 2016–17 academic years, tuition, fees, and room and board rose 24% at private nonprofit colleges and universities and 31% at public institutions as reported by the U.S. Department of Education, National Center for Education Statistics (numbers adjusted for inflation).
According to CollegeBoard, annual tuition costs $32,410 on average for a private four-year college and $9,410 for a public four-year college for in-state students.
These published prices are referred to as the “sticker” price, and most students end up paying less due to financial aid. But that price doesn’t take into account room and board, transportation costs, food, books, or other supplies. And financial aid often comes in the form of loans.
As of the end of 2019, student loan debt topped a collective $1.6 trillion among more than 44 million Americans. The average student loan debt is $32,000, but over three million students have an excess of $100,000 in debt.
A bachelor degree earns someone an average of $1,198 per week versus an average of $730 for those with a high school diploma, according to the U.S. Bureau of Labor Statistics. But that doesn’t mean those that went that the higher education route are able to easily pay off those debts. As the numbers previously mentioned indicate, the student debt crisis is alive and well.
The first step to a strategic approach to funding higher education is to understand the different types of loans available—and your alternatives.
Are Federal or Private Student Loans Better?
The main way students and their families cover the costs of college is via loans. However, federal and private loans come with extremely different terms and conditions.
A federal student loan is a loan administered by the federal government. To get federal loans, you must fill out the Free Application for Federal Student Aid (FAFSA) form.
There are several types of federal student loans, such as Direct Subsidized Loans for undergraduate students with financial need (you are not responsible for interest while attending college, among other periods) and Direct Unsubsidized Loans for undergraduate, graduate, or professional students regardless of financial need (you are responsible for interest).
Federal student loans are usually preferable to private student loans because they often have lower, fixed interest rates and more favorable terms for students, such as income-driven repayment plans and loan forgiveness programs. With the exception of the Federal PLUS Loans for graduate and professional students or parents, federal loans do not require a credit check.
A private student loan is a loan administered by private lenders, such as banks, credit unions, or the school you’re attending.
Private student loans are almost always unsubsidized and vary greatly based on the lender. For example, a Sallie Mae loan has fixed interest rates that vary from 4.74% to 11.85% and variable interest rates from 2% to 10.01%. Borrowers with better credit scores can secure lower interest rates, but if you opt for a fixed interest rate or deferred repayment program, your interest rate will be higher.
Beware: The Dangers of Deferment and Forbearance
Many federal and private loans offer the option for deferment or forbearance. Both offer the option to suspend payments for a length of time, but you must request them.
Deferment is generally tied to a specific event, such as attending school or enrolling in the military or Peace Corps service. The length of deferment depends on the specific qualification and your lender must grant you deferment if you meet the qualifications.
You can request forbearance for general reasons, such as financial difficulty, but your lender can decide whether or not to grant it. Or you can request it for mandatory reasons, such as serving in AmeriCorps. Forbearance lasts for one year (though you may be able to request forbearance again).
Many students, because they’re focused on studying while in school and choose not to work simultaneously, opt to defer payments until after graduation. But for private loans and most federal loans, you’re still accruing interest and responsible for paying it during deferment. You’re responsible for interest on all loans during forbearance. This interest is usually capitalized—or added—to your principal balance at the end of the deferment or forbearance period. Interest is then calculated based on this higher principal balance, increasing the amount you pay over the course of your loan.
While it’s tempting to put off payments, particularly while attending college, it may not provide the lasting relief you want. Instead, as interest piles up, you may find the student loan debt hole widening, making it more difficult to get out.
Your Student Loan Alternatives
If you’re a homeowner preparing to send your children to school, you have the option of using the equity you’ve built in your home to fund their education. In fact, the roughly 200 schools that require a CSS profile in addition to the FAFSA form take into account your home equity when calculating financial aid.
Read "How Your Home Equity Impacts Financial Aid For College" for more details.
That’s because your property is an asset that you can use to help cover the costs of college, or, at the very least, reduce the amount of loans you need to take out (and the amount of debt that comes with it). But if your goal is avoiding debt, you may feel taking out a home equity loan is simply swapping one type of debt for another with the added stress of needing to make payments to avoid risk of foreclosure.
But there are multiple options for accessing your home equity and not all of them are loans. A home equity investment allows you to access a portion of your home equity now in exchange for a share of the future value of your home. Since it’s an investment, not a loan, there are no monthly payments or interest. This can help families alleviate some, if not all, of the debt burden.
If college days are far behind you, but the debt is still being paid off, you can use your home equity to reduce or eliminate your student debt, too.
Read why John M. chose Hometap to help fund his child’s education
The best way to finance your education or a family member's education depends on your specific financial situation. You may find a combination of tapping into your home equity and borrowing loans is the best approach, or that using your home equity can cover all your costs. Explore all your options, including what interest rates you can secure for various types of loans and how much funding you may get from a home equity investment, to see what makes the most financial sense.
See if a Hometap Investment could help you fund an education or pay off school loans.
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The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.