What are the Risks in Getting a Private Student Loan vs. Federal?

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By Mark Kantrowitz

June 2, 2020

Borrowing a student loan comes with risks, since student loans must be repaid, with interest. The risks of borrowing a private student loan differ from the risks of borrowing a federal student loan.

Many of the risks depend on several important differences between federal and private student loans. Some the risks are associated with borrowing a student loans and some of the risks are associated with repaying a student loan.

Risks Related to Interest Rates

Interest rates on federal loans are fixed, while interest rates on private student loans may be fixed or variable. A variable interest rate may increase as frequently as monthly, depending on the lender.

The interest rate on a private student loan is based on the credit scores of the borrower and cosigner, while the interest rates on federal student loans are the same for all borrowers.

So, a borrower with excellent credit may qualify for a private student loan with a lower interest rate, but most borrowers will have a higher interest rate on a private student loan than on a federal student loan.

Risks Related to Cosigning a Student Loan

Private student loans require a creditworthy cosigner, while federal student loans do not.

A cosigner is responsible for repaying the loan, just like the primary borrower. A cosigner is not a reference or a contingent borrower.

The cosigned loan will appear on the cosigner’s credit history and will affect the cosigner’s ability to get new loans, including auto loans, credit cards and mortgages. Having cosigned a loan may also affect the interest rates available to the cosigner, especially if there are late payments on the cosigned loan.

A default on a cosigned loan will ruin the cosigner’s credit, even if the default was not the cosigner’s fault.

Risks Related to Difficulty in Repaying a Student Loan

Federal student loans offer more options for borrowers who are struggling to repay their debt. They offer deferments, such as the economic hardship deferment and unemployment deferment, where the federal government pays the interest on subsidized loans. They offer longer deferments and forbearances than private student loans.

Federal loans offer income-driven repayment plans, which base the loan payments on the borrower’s discretionary income, as opposed to the amount owed.

Federal student loans allow borrowers to change repayment plans, and offer standard repayment, extended repayment, graduated repayment and income-driven repayment. Most fixed-rate private student loans do not allow changes in the repayment term or repayment plan.

Federal student loans offer several student loan forgiveness options, while private student loans do not.

Private student loans go into default quicker than federal student loans. If the borrower does not make a required payment on a private student loan for 120 days, the loan goes into default. This compares with default occurring after 270-360 days of non-payment on federal student loans.

Federal student loans offer death and disability discharges. Two-thirds of private lenders offer a death discharge and less than half offer a disability discharge. Federal student loans also offer closed school discharges, identity theft discharges, unpaid refund discharges and false certification discharges.

During the coronavirus pandemic, federal student loans offered an automatic 6-month payment pause and interest waiver. Private student loans offered a 90-day COVID-19 forbearance, upon request, and did not waive the interest.

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