What are the different types of student loans?

Key points

• There are two main types of student loans: federal and private.
• Annually, about 40% of adults who attended college used student loans to pay for a portion of their expenses.
• To get federal loans, you’ll need to complete the FAFSA every year.
• Private student loans require a solid credit score and history for eligibility.
• Most private student loans require a creditworthy cosigner.

Are you sitting down? A single year of tuition and fees at a four-year college costs $10,740 to $38,070, depending on the type of school you choose. Gulp.

If you need to borrow student loans to pay for college, there are a few different types to choose from. The ones you pick matter — your interest rate, repayment terms and perks all depend on the type of student loans you take out.

Before you borrow, make sure you’ve exhausted all your free money options first. Scholarships and grants are types of student aid that don’t need to be repaid. The more free money you get to cover your education costs, the less you’ll need to borrow in student loans.

After you’ve used up all the free money you can find, it’s time to apply for student loans. Each year, about 40% of adults who went to college use student loans to cover some of their costs. Here’s the breakdown of the different types of student loans you can borrow to pay for school.

Federal student loans

Federal student loans are loans you take out with the U.S. Department of Education. While you borrow money from the federal government, the Department of Education has contracts with private lenders to service the loans.

“Students should always exhaust their federal student loan eligibility before turning to private loans,” says Michele Streeter, associate director of policy and advocacy with The Institute for College Access & Success (TICAS). “​​Federal student loans offer lower interest rates and much more favorable terms than private loans.”

To get any federal student loan, you’ll need to complete a Free Application for Federal Student Aid, or FAFSA. This is your ticket to all federal aid, including federal student loans. To complete the FAFSA, you’ll need tax returns (for students and parents or just for students, if they are independent), bank and brokerage account statements, and other financial information. These determine the Expected Family Contribution (EFC), or how much your family is on the hook for when it comes to paying for school.

Types of federal student loans

There are a few different student loans you might be eligible for. The types of federal student loans are:

Direct subsidized loans. These loans are given to undergraduate students based on financial need. The government covers the interest payments (or subsidizes) for the entire time you’re in school at least half-time. You’re responsible for interest that gets charged to your loans once you graduate. The amount you can borrow is capped based on your year in school. For instance, first-year students can’t get more than $3,500 in subsidized loans.

Direct unsubsidized loans. Anyone can borrow unsubsidized loans and they aren’t based on financial need. You’re on the hook for interest charges while you’re in school, although you can defer payments until after you graduate or drop below half-time enrollment. You’re still limited to how much you can borrow, but it’s not as low as subsidized loans. First-year dependent students can borrow as much as $5,500 (with $3,500 of that $5,500 as the max allowed in subsidized loans).

Direct PLUS loans. These loans are available to graduate or professional students or parents of undergraduate dependent students. Eligibility isn’t based on need but there is a credit check required. This is the only federal loan that requires a credit check, so having an adverse credit history could hurt your chances of qualifying. Eligibility does not, however, depend on credit scores. This loan covers the cost of education after all other aid has been applied.

Direct consolidation loans. You can take out this consolidation loan to combine all your eligible federal student loans into one. Your interest rate is the weighted average of your federal loans rounded up to the nearest one-eighth percent.

Here’s a closer look at Direct Subsidized, Direct Unsubsidized and Direct PLUS loans:

Due to limits on how much you can borrow per year, you’re essentially taking out a new loan for every year you’re in school. Because of this, you might get multiple student loans even though you’re one student attending the same school for your entire college career. Some students take out a Direct Consolidation Loan to combine all those federal loans into one easy monthly payment after graduation.

Federal loan eligibility

Federal student loans are a unique form of debt in that most of them don’t require borrowers to undergo credit checks or meet income requirements. “Federal student loans are available to all students and everyone receives the same fixed rate,” says Streeter.

Instead, borrowers qualify if they meet the following criteria:

• They must be a U.S. citizen, permanent resident or eligible noncitizen.
• They must have a valid Social Security number (SSN). Students from the Republic of the Marshall Islands, Federated States of Micronesia or the Republic of Palau do not need an SSN.
• They must be enrolled in or accepted by an eligible institution in a qualifying degree or certificate program.
• They must be enrolled at least half-time.
• They must have a high school diploma, GED or recognized equivalent.

For graduate students and parents who want to take out PLUS loans, borrowers must undergo credit checks. If they have adverse credit histories — such as recently declaring bankruptcy or foreclosing on a home — they may be denied a loan unless they have a creditworthy individual willing to serve as an endorser on their loan application.

How to apply for federal student loans

To apply for federal student loans, you must fill out the Free Application for Federal Student Aid (FAFSA). The FAFSA will ask you questions about your income, assets and family size to determine your financial need. Your college’s financial aid office will use that information to create your award package, which may include scholarships, grants and federal student loans.

Repaying federal student loans

Federal student loans give you a six-month grace period, meaning you don’t have to start repayment until six months after you graduate or drop below half-time enrollment. You’ll get a letter after graduation letting you know how to start repayment with your assigned loan servicer.

By default, you’re enrolled in the Standard Repayment Plan after you leave school. You can change your repayment plan at any time.

If you’re planning to enroll in Public Service Loan Forgiveness (PSLF), you’ll need to get into an income-driven repayment (IDR) plan or standard repayment plan. Graduated and extended repayment plans are not normally eligible for PSLF, although Temporary Expanded Public Service Loan Forgiveness (TEPSLF) allows these repayment plans if the last year of payments is at least as much as they would have been under an income-driven repayment plan. The remaining debt is forgiven after 120 payments (10 years).

If a borrower does not pursue Public Service Loan Forgiveness, the balance is forgiven after 240 or 300 payments (20 or 25 years) in an income-driven repayment plan, depending on which plan you choose.

Private student loans

While federal student loans come from the federal government, private loans come from private financial institutions, like banks, credit unions and online lenders.

Since there’s no universal standard for private student loans, it’s up to each individual lender to determine how much you can borrow, your repayment terms, your interest rate and what you need to qualify. While most federal student loans don’t run a credit check, all private student loans require it. So if you don’t qualify to borrow on your own, you might need the help of a cosigner to be eligible for a private student loan. A cosigner agrees to take out the loan with you. If you fall behind on payments or can’t pay it back, you and your cosigner will see your credit scores drop.

For most private student loans, you’ll need a decent credit score and proof you’ll pay the loan back. Repayment terms range from as little as five years or as long as 20 years, depending on the lender and the terms you’re approved for.

A private student loan should be your last stop when it comes to borrowing money to pay for school. If you’ve exhausted all your free money and federal aid options, private student loans can cover your funding gaps. But these don’t come with the same protections and repayment options as federal student loans, including deferment, forbearance and income-driven repayment plans. Use with caution.

How to apply for private student loans

Since private loans are issued by individual lenders, you have to apply for loans by contacting the lender directly and submitting an application, usually through the lender’s website. Many lenders offer pre-qualification tools that allow you to check your eligibility and get a rate estimate without affecting your credit score.

5 key differences between federal and private student loans

So which loan is best for you: federal or private? In most cases, federal student loans are a better option.

“Private loans — those made by banks and other private lenders — are one of the riskiest ways to pay for college,” says Streeter. “They typically cost more than federal loans and do not guarantee the same consumer protections or repayment options as federal loans.”

That’s because federal loans differ from private loans in the following ways:

Borrowing limits

The government limits how much undergraduate students can take out in federal loans.

“The drawback on federal loans is that students are limited to the amount that they can borrow each year, up to a total of $31,000 for undergraduates,” says Joe Orsolini, president of College Aid Planners, referring to dependent undergraduates specifically. “Although some would argue this is actually a plus because it prevents students from overborrowing.”

Private loans don’t have that restriction. Undergraduate students usually can borrow up to the school-certified cost of attendance, which may be more than they can afford to repay.

Interest rates

Historically, federal student loans have much lower interest rates than private student loans.

According to Sallie Mae, from February 2021, the average interest rate on their private student loans was 8.42% in 2020, 9.32% in 2019 and 9.10% in 2018.

By contrast, the interest rate for undergraduate federal loans disbursed on or after July 1, 2021, and before July 1, 2022, was just 3.73%. Over time, the difference between the typical rates can cost borrowers thousands in additional interest charges.

Interest rate types

Higher rates aren’t the only issue with private loans. Although federal loans have fixed interest rates that stay the same for the duration of the loan, private student loans can have variable or fixed interest rates.

Initial variable rates are often very low, making them an appealing option. However, rates can fluctuate over time, causing the monthly payment and overall repayment cost to increase.

Repayment options

If you can’t afford your payments, federal loans have more options than private loans. As a federal loan borrower, you can enroll in an income-driven repayment (IDR) plan to get a lower payment. IDR plans base your payments on a longer repayment term and a percentage of your discretionary income. Some borrowers even qualify for $0 payments.

If you have private student loans, your options may be limited. Not all private lenders offer alternative payment plans. Even if they do, they tend to be temporary.

Loan forgiveness

Federal loan borrowers can be eligible for loan forgiveness programs like Public Service Loan Forgiveness (PSLF), Teacher Loan Forgiveness and IDR forgiveness. Again, PSLF is for borrowers who work for nonprofit organizations or government agencies full-time for at least 10 years while making 120 qualifying monthly payments; these borrowers may qualify for complete loan forgiveness.

For Teacher Loan Forgiveness for Federal Stafford Loans, you must teach for five years in a low-income school; STEM and special-needs teachers get $17,500 forgiven and other teachers get $5,000.

If you enroll in an IDR plan and still have a balance at the end of your new loan term — 20 or 25 years, depending on the plan — the government will forgive the remainder.

Private student loans aren’t eligible for federal loan forgiveness programs.

Hardship programs

If you lose your job or have a medical emergency, federal loans can be much more flexible than private ones. You may qualify for a federal deferment or forbearance and postpone your payments. Depending on the type of deferment or forbearance you qualify for, you could potentially delay your payments for up to 12 months at a time, for a maximum of three years per deferment or forbearance.

Some private student loan lenders offer financial hardship programs, but they are much more restrictive. You can usually only delay payments for one to three months, and total forbearance is typically limited to 12 months or less for the duration of your loan.

College financing options

If you need to borrow money to pay for college, think about all of your options.

“People should consider what the loan payment will be when they graduate,” advises Orsolini. “Too often, people pile on debt that can’t be supported by their chosen career. Make sure you will be able to afford the payment later.”

For most borrowers, federal loans are the best choice. While private loans may seem appealing with their low advertised rates, their credit requirements tend to be strict, and they have fewer repayment options and hardship programs if you run into financial issues later on.