What is the Difference Between Federal and Private Student Loans?
There are several important differences between private student loans and federal student loans – both in the manner in which they can be obtained and manner in which they can be collected in a borrower defaults.
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Private Student Loans
- What Are Private Student Loans? Private student loans are loans taken out from private lending institutions. These loans are based on the borrower’s credit, similar to a mortgage or car loan.
- Defaulting on Private Loans If you default on a private student loan, the lender must file a lawsuit to get a judgment against you. This could lead to:
- Wage garnishment
- Bank account freezing
- Property liens
- Statute of Limitations The statute of limitations for private student loans is determined by the promissory note or New York State law.
Important Note: Some private loans may be federally guaranteed, in which case no statute of limitations applies, similar to federal loans.
Federal Student Loans
Types of Federal Student Loans
- Direct Loans: These loans come directly from the Department of Education (Dept. of Edu.) through the William D. Ford Direct Loan Program. Payments are made directly to the Dept. of Edu. or its loan servicer.
- FFELP Loans: Federal Family Education Loan Program loans were previously offered through private institutions but are no longer available as of 2010.
Popular Types of Federal Loans
- Stafford Loans: These can be subsidized (where the government pays the interest during deferment) or unsubsidized (where interest accrues during deferment).
- PLUS Loans: These loans are for parents of undergraduates or graduate students. The eligibility for PLUS loans is based on creditworthiness.
- Perkins Loans: Funded and repaid directly through schools, guaranteed by the Department of Education.
- No Statute of Limitations for Federal Loans Unlike private student loans, federal student loans have no statute of limitations, making it possible for the government to collect the debt indefinitely.
Collection Tools for Defaulted Private Student Loans
- Legal Actions: Private lenders can sue you in court for breach of contract if you default on a private student loan.
Possible Outcomes:
- Wage Garnishment: A portion of your wages can be withheld.
- Bank Account Restraints: Your accounts can be frozen.
- Liens on Property: Lenders can place liens on your property to recover the debt.
- Bankruptcy: Private student loans are typically not dischargeable in bankruptcy, unlike some other types of unsecured debt like credit cards or medical bills.
Repayment Options for Federal vs. Private Loans
Federal Loan Repayment Plans
Federal student loans offer several flexible repayment plans to help borrowers manage their debt more easily. Some of the key options include:
- Standard Repayment Plan: This is the default plan where borrowers make fixed monthly payments over 10 years.
Income-Driven Repayment (IDR) Plans: These plans adjust monthly payments based on your income and family size. The most common IDR plans include:
- Income-Based Repayment (IBR)
- Pay As You Earn (PAYE)
- Income-Contingent Repayment (ICR)
Revised Pay As You Earn (REPAYE)
- Graduated Repayment Plan: Payments start low and gradually increase every two years. This plan is ideal if you expect your income to grow over time.
- Extended Repayment Plan: This plan allows you to extend payments up to 25 years, which lowers your monthly payments but increases the overall interest paid.
- Private Loan Repayment Terms
Private lenders do not offer the same variety of repayment plans as federal loans. Repayment terms for private student loans are often: - Fixed Interest Rates: Most private loans come with fixed interest rates, which remain the same throughout the loan term.
- Variable Interest Rates: Some private lenders offer variable interest rates, which can change over time based on market conditions. This means your monthly payment could increase.
- Less Flexibility: Unlike federal loans, private loans typically have limited options for income-driven repayment, deferment, or forbearance. Borrowers with private loans may face difficulty if they experience financial hardship.
Loan Consolidation and Refinancing
Consolidating Federal Loans
Federal student loans can be consolidated into a Direct Consolidation Loan. This allows you to combine multiple federal loans into one loan with a single monthly payment. Key benefits include:
- Simplifying payments with just one monthly bill.
- Potential access to alternative repayment plans or loan forgiveness options.
- Extending the repayment term to reduce monthly payments.
However, consolidating federal loans may result in losing borrower benefits, such as interest rate discounts or loan cancellation benefits.
- Refinancing Private Loans
Refinancing involves taking out a new loan to pay off existing private loans. This can be a good option if you want to secure a lower interest rate or better repayment terms. Key points to consider: - Lower Interest Rates: If you have a good credit score, refinancing may help you secure a lower rate, reducing the overall cost of the loan.
- Changing Loan Terms: Refinancing gives you the option to change the term of the loan (e.g., 5 years, 10 years) depending on your financial situation.
However, refinancing private loans comes with risks:
- Loss of Federal Loan Protections: If you refinance federal loans into a private loan, you lose access to federal protections like income-driven repayment plans and loan forgiveness.
- Stricter Requirements: Private lenders may have stricter qualifications for refinancing, requiring good credit scores or a stable income.
The Role of Cosigners in Private Student Loans
- Cosigner Obligations
Private student loans often require a cosigner, especially for borrowers with little to no credit history. A cosigner can help secure the loan by agreeing to take responsibility for the debt if the borrower defaults. Cosigners should be aware of the following: - Shared Responsibility: If the borrower misses payments, the cosigner is legally obligated to repay the debt.
- Impact on Cosigner’s Credit: Late payments or defaults can negatively affect the cosigner’s credit score.
- Removing a Cosigner
If you initially took out a private student loan with a cosigner, you may want to remove them from the loan once your credit improves. To remove a cosigner, you typically need to: - Refinance the Loan: Refinancing may allow you to take out a new loan in your name only, removing the cosigner from the responsibility.
- Meet Credit Requirements: You’ll need to meet certain credit qualifications to refinance without a cosigner. This may include having a strong credit score and a steady income.
If refinancing isn’t an option, some lenders may offer a cosigner release after a set period, provided you’ve made on-time payments and meet specific requirements.
Collection Tools Available For Defaulted Federal Student Loans
Although federal student loans usually have lower interest rates, better repayment options, etc., they also have greater authority to collect payment when the borrower enters default. For example, collection efforts can range from any of the following for federal loans:
- Your loans may be sent to a third party debt collection agency;
- You will be liable for the costs associated with collection your loan (including court costs and attorney’s fees);
- You can be sued for the entire amount of your loan;
- Your disposable income may be garnished up to 15% administratively (i.e. without a lawsuit);
- Your federal and state income tax refunds may be intercepted;
- The federal government may withhold part of your Social Security benefit payments;
- Your defaulted loans will appear on your credit for 7 years;
- You won’t receive any additional federal financial aid until certain requirements are met;
- You’ll be ineligible for deferments;
- Subsidized interest benefits will be denied;
- You may not be able to renew a professional license you hold; and
- You may be prohibited from enlisting in the Armed Forced.
FAQ: Federal vs. Private Student Loans
Can I refinance federal student loans with private lenders?
- Yes, you can refinance federal student loans with private lenders. However, it's important to understand that by doing so, you will lose access to federal protections, such as income-driven repayment plans, deferment, and forgiveness options. Refinancing federal loans can make sense if you want to secure a lower interest rate and are comfortable with the loss of federal benefits.
How can I qualify for an Income-Driven Repayment (IDR) Plan?
- To qualify for an Income-Driven Repayment (IDR) plan, you must have a federal student loan and meet specific income requirements. The plans base your monthly payment amount on your discretionary income, and you will need to provide documentation of your income and family size annually. If your income is low, this can significantly reduce your monthly payments.
What happens if I miss a payment on my private student loan?
- If you miss a payment on a private student loan, the lender may impose late fees, report the missed payment to credit bureaus, and eventually take legal action if the loan goes into default. Missing payments can negatively affect your credit score and could result in wage garnishment or other collection actions.
Is there a limit on how long I can be on an Income-Driven Repayment (IDR) plan?
- Yes, depending on the specific IDR plan, there is a limit to how long you can remain in the program. Typically, your loan balance may be forgiven after 20 to 25 years of qualifying payments, depending on the plan. However, any forgiven amount may be considered taxable income.
Can I consolidate my private student loans into a federal loan?
- No, you cannot consolidate private student loans into a federal loan. Federal consolidation programs are only for federal loans. However, you can refinance private loans into a new private loan, which may offer better rates or terms depending on your creditworthiness.
What should I do if I can’t make my private student loan payments?
- If you cannot make payments on your private student loan, it’s crucial to contact your lender immediately. Many private lenders may offer deferment or forbearance options to temporarily reduce or delay payments. Additionally, explore refinancing options if you qualify, or see if you can modify your repayment terms. Ignoring the problem can lead to severe financial consequences, such as wage garnishment or a lawsuit.
Need assistance with your student loan issues? Contact us at (888) 801-7765 for a free consultation and learn how we can help you.