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What's the difference between federal and private loans?

After completing the Free Application for Federal Student Aid (FAFSA) to see what grants, loans and other assistance you may qualify for to help pay for college, you'll receive a financial aid award letter from your school of choice listing what aid you may be eligible for at that institution. That may include any scholarships, grants, work study and for most applicants, loans to help with the cost of attendance.

Many prospective students are surprised to learn that there is a limit on the amount of federally-based student loans that can be offered each year. In many cases, that loan amount is not enough to cover the cost of attending, and if the student doesn't have other resources such as savings to cover the balance, they may turn to private loans. If you are applying to a private college, the school itself may also offer you loans in addition to the federal loans available.

Before you select which aid you'll accept, it's important to know the difference between federal and private loans.

Federal student loans include Direct Subsidized, Direct Unsubsidized and Direct PLUS loans for parents or graduate and professional students. These loans are made by the US federal government with terms and conditions that are set by law. Any other type of student loan, including those offered by a private school directly, your bank or state-affiliated organizations are considered to be private loans.

Because federal loans are made according to the current laws set for student aid, they are generally considered to be more favorable due to the benefits that are available including fixed interest rates, a variety of flexible repayment plans and the ability to defer loans when certain circumstances exist such as a loss of income or going back to school.

While private loans sometimes offer some of these benefits, they are not required to by law, and therefore you need to be much more aware of the terms when accepting this type of aid.

Repayment terms
For example, federal student loans give borrowers a grace period after you graduate, leave school or reduce your enrollment to less than half-time, and they don't require payments while you're actually attending school.

Some private loans offer this as well, but not all – you may find that you have to make payments while you're still taking classes (and possibly not earning any income), or payments could kick in immediately after you leave school, regardless of whether you've found employment. Federal loans have a provision that allows you to postpone payments until you're earning enough to afford the payments, even after you've graduated. Most private loans do not have this and expect you to begin paying no matter what.

Interest rates
Likewise, the interest rate for federal loans is set by law and fixed – you don't have to worry about the rate changing as the economy changes. Private loans can come with variable or fixed rates, some which could be lower than the rate set for federal loans.

Tax deductions
One thing is the same for all types of loans that you take out for higher education: in most cases, the interest you pay on your loans is tax deductible as long as you're within the income limits set by the IRS.

The most important thing to know is that when it comes to deciding between federal and private loans to fund your education, is that most of the benefits you hear about student loans are referring to federal loans. There are types of private loans that offer great benefits for people in certain professions or certain economic situations, you just need to be sure you are fully aware of the terms and conditions for before you accept these loans.

For more information on federal loans, check out the US Dept of Education's Federal Student Aid website.