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Student Loan Debt: Federal Loan or Private Loan?

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Student Loan Debt: Federal Loan or Private Loan?This is the fourth of a four part article series on student loan debt.  This article covers the basics of deciding between a federal loan and a private loan.  Other articles cover an introduction to student loans, private student loans, and federal student loans.

I recently read that student loan debt now exceeds $1 trillion and is currently the largest source of unsecured consumer debt.  The delinquency rate on student loan debt for 2010 – 2012 was 15% in the US.  Those are scary statistics.

Federal Loan or Private Loan?

If at all possible, try and save for college rather than take out student loans.  If that’s not possible,  it’s important to understand and weigh the pros and cons of a federal loan with the benefits and disadvantages of a private loan.  There are a number of very important differences between a federal loan and a private loan that many people are not aware of.

As a general rule of thumb, most people are likely better off exhausting all federal loan options before turning to a private loan.  However, students and/or co-signers with excellent credit may be offered a private loan with very attractive interest rates and may also have fees waived.  For these borrowers, I think it makes a lot of sense to compare their private loan and federal loan alternatives rather than just automatically assuming that a federal loan will always be the better choice.

Additionally, since there is a limit to the amount of money you can borrow using a federal loan, more and more students are taking out both federal and private loans.

With a little bit of research, most people are probably more than capable of making student loan decisions on their own.  However, if you would like assistance, a financial advisor can assist you in deciding whether a federal loan or private loan is more appropriate for you.

Additional Student Loan Debt Options

In certain cases it may make sense to consider a home equity loan (or line of credit) to finance an education, especially if you don’t qualify for the student loan interest deduction.

As a general rule of thumb, most people shouldn’t use retirement assets to pay for their children’s education.  Most students have student loan options available to them, but nobody will loan you money for retirement.

Questions to Ask

It’s important to understand the terms of any student loan you are considering so you can make an informed decision.  Here are a few questions to ask:

  • What type of loan is it?
  • Who is the lender?
  • How much is the loan for?
  • Is the rate variable or fixed?
  • What fees are involved?
  • What are the terms of repayment?
  • What if I can’t make my payments?
  • If the rate is variable, how is it calculated and is there a cap on the rate?

Obtaining the Best Rates

Since rates on private student loans vary widely by lender, you can save yourself thousands of dollars in interest by shopping around for the best loan for you.

Many private lenders require students to have a decent credit score.  This can be difficult for many students who have never had credit.  Many of these students must then have their parents co-sign on a loan.  Fortunately, there are a lot of things a student can do to begin building credit.

Before applying for a private student loan or a PLUS loan, check your free credit report for accuracy.  Also check your FICO score (credit score used by most lenders).  If your parents, spouse, or grandparents will be co-signing, have them also pull their credit report and FICO score.

In addition to the interest rate you are charged, make sure you also pay close attention to fees.  Fees can significantly increase the cost of a loan.

Paying off Your Student Loan Debt

If you graduate with student loan debt, come up with a responsible plan to get out of debt as soon as possible.

If you are having trouble making your federal loan payments, look into any applicable deferral options or repayment plans.  If you are finding it difficult to make your private loan payments, look at your loan agreement or contact your lender to see what your options are.

Remember that up to $2,500 of interest paid on student loan debt may be deductible if certain requirements are met.  This can help ease the pain of paying off your student loan debt.  However, this deduction may not be available to higher income taxpayers.

Also keep in mind that there are some federal and state programs that will forgive government loans in exchange for public service.  However, remember that there are strings attached and certain conditions must be met.

Life Insurance for a Private Loan

It may be wise to take out life insurance on the life of any student with a private loan.  A Federal loan will oftentimes be discharged if the student/graduate dies, but a private loan may not, and a co-signer could be required to repay the loan.

Term life insurance is an easy, affordable way to hedge against such risk.  Compare prices and find the best policy for you.  Make sure you purchase enough life insurance coverage to cover the amount of the student loan debt.  You could probably get $100,000 of life insurance coverage on a typical non-smoking student for as little as $10 or so per month, making it a very inexpensive way to hedge your risk.

Final Student Loan Debt Tips

  • Don’t borrow more money than you need to.  Remember you will have to pay this money back some day.
  • Make sure your loan makes sense and that you will be able to pay it off.  It may not make sense to borrow $150,000 in order to earn a degree that will pay you $30,000 a year.

Additional Student Loan Information

For additional student loan information, you might take a look at the below books:

What are your thoughts about student loan debt?  Did you take out a federal loan or a private loan to get you through school?  Leave a comment below!

Image: zimmytws/Bigstock

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