Introduction

When it comes to paying for higher education, many students and families turn to student loans to cover the cost of higher education.  It is important for borrowers to be informed about the differences between types of available loans.  As of July 15, 2024, student loan debt in the United States totaled $1.753 trillion – 91.2% of which was federal student loan debt; and 8.8% (approximately $133 billion) of which was private student loan debt.^[i] 

This blog will focus on and highlight the differences between private student loans and federal student loans – specifically the protections (or lack thereof) for private student loan borrowers.  For the reasons discussed below, student loan borrowers should exhaust all publicly available assistance options (grants, scholarships and federal loans) before turning to private student loans. 

What are Private Student Loans?

Private student loans are offered by private lenders such as banks, credit unions, and online financial institutions.  Unlike federal loans, which are funded by the government, private loans are issued based on a borrower’s creditworthiness, often requiring a cosigner.  The main purpose of private loans is to cover the shortfall between the cost of attendance and all other types of assistance (such as federal loans, grants and scholarships).  The “cost of attendance” may include tuition and fees, housing expenses, transportation to/from school, meals, textbooks and supplies, and other education-related expenses.

During the application process for a private loan, the lender will, after reviewing the borrower’s application for creditworthiness, contact the school’s financial aid office to determine: (a) the cost of attendance, and (b) the amount of any other financial aid received by the borrower.

Who Uses Private Student Loans?

According to The Institute for College Access and Success (TICAS), only 6% of undergraduates borrowed private student loans in 2019-2020.^[ii]  Of those students:

• ~11% did not apply for any federal aid.
  • ~16% applied for, but did not take any federal aid.
  • ~32% did not take the maximum amount of federal aid available.
  • ~36% received need-based grants.

As noted, it is generally advisable for student loan borrowers to maximize publicly available assistance (grants, scholarships, and federal loans) before turning to private student loans.

Differences Between Federal Student Loans and Private Student Loans

Borrower/Lender Relationship and Rules

Private student loans are creatures of contract.  Aside from certain provisions of consumer protection law (which are often hard to prove and enforce), the private student loan contract controls all aspects of the borrower/lender relationship. 

Federal student loans, on the other hand, are governed by numerous federal statutes and regulations which include provisions related to delinquency and default, deferment and forbearance, and repayment and (in certain circumstances) forgiveness and discharge. 

Interest Rates

As of October 2024, private loans have interest rates ranging from 3.59%-17.99% (for fixed-rate loans)  and 5.00%-17.99% (for variable-rate loans). ^[iii]  Whereas, federal loans have only fixed interest rates: 6.53% for undergraduate loans; 8.08% for Direct Unsubsidized loans for graduate school; and 9.08% for PLUS loans (for Parents funding their dependent children’s undergraduate education or for Graduate and Professional Students).^[iv]

A careful reader might notice that private student loans currently offer low interest rates. However, there are a few important caveats to consider before rushing to apply for them:

1. (Remember) Private student loans are based upon creditworthiness so only borrowers with top-tier credit ratings (which is not usually the case for a typical college student) will be offered loans with 3.59% fixed or 5.00% variable interest rates;
2. Private loans may carry a default interest rate which can be significantly higher than the initial rate; and
3. Variable interest rates played a large role in the 2007-08 financial crisis.  Low-interest rate environments often favor those with variable rate loans; however, rising interest rates can be devastating to borrowers holding variable interest rate loans – adding hundreds of dollars to monthly payments.

Repayment Plans

The repayment options for federal student loans can be found in various federal statutes and regulations.  Those options include fixed and graduated repayment plans with payback periods ranging from 10-30 years (depending on whether the loans are consolidated and on the loan balance) and Income Driven Repayment (IDR) plans in which payments are generally based on income, family size and tax-filing status rather than on the loan balance and interest rate.

The repayment options for private student loans are likely to be far more limited.  Although there is some guidance from the federal government on what plans private student loan lenders and servicers should offer[v], the repayment options available to any specific borrower will depend on the terms of the loan contract and the policies and procedures of the private lender or servicer.

Deferment & Forbearance

As with repayment plans, deferment and forbearance periods available to a federal student loan borrower are outlined by federal regulations.^[vi]  There are many situations in which a borrower may defer or forbear payment on federal student loans including, but not limited to, periods where the borrower is in school, unemployed, facing economic hardship or in military service.

With private student loans, there is no legal requirement that a lender or servicer agree to defer or forbear any periods of repayment for any reason.

Forgiveness & Discharge

There are a number of regulatory programs which allow for partial or total forgiveness and discharge of federal loans.  Those programs include public service loan forgiveness (“PSLF”),^[vii] total and permanent disability discharge,^[viii] and closed school discharge.^[ix]  Additionally, federal student loans discharge upon the death of the borrower.

With private student loans, there is no legal requirement that a lender or servicer have any programs for forgiveness or discharge and most private lenders do not have any such programs – not even for death of the borrower.

Cosigners

A whole article could be spent on this topic alone.  In brief, federal student loans generally do not require a cosigner, whereas private loans often do.  Many times, the cosigner is a family member or relative of the student borrower.  Too often, a cosigner believes that they are only responsible for repayment if the student borrower fails to repay the loan; but the cosigner and student borrower are both primarily and equally responsible for repayment of the loan.  Failure to pay will impact both the student borrower’s and cosigner’s credit rating, subject both to lawsuits and can lead to an irretrievable breakdown in the relationship between the student borrower and cosigner.

What Options are Available for Borrowers Struggling to Repay?

Contact Your Lender/Servicer

There is no legal requirement that a lender or servicer modify the terms of a private student loan contract.  That said, the lender/servicer would rather have a performing loan than a loan in default and, consequently, may be willing to work with a struggling borrower to create an affordable repayment plan or modification of the loan terms.  Many servicers will not discuss any type of workout unless and until the loan is in default.

Refinance with Third-Party Lender

It may be possible for a borrower to refinance their student loans with a different lender.  It is also possible to remove or replace a cosigner through refinance.  Unfortunately, the longer a loan is delinquent, the less likely refinance will be a viable option.

Bankruptcy 

It’s a common misperception that student loans cannot be discharged in bankruptcy.  They can be…but it’s difficult.  To qualify for a bankruptcy discharge of student loans, a borrower must prove an “undue hardship” which requires a showing that: (1) the borrower cannot maintain a minimal standard of living if forced to repay the loans, (2) that state of affairs is likely to persist for a significant portion of the repayment period, and (3) the borrower has made good faith efforts to repay the loans.

Get Legal Help

Unlike federal student loans, private student loans require a lawsuit and judgment before any involuntary collection efforts can begin. If you are served with a lawsuit, it’s crucial to contact an attorney immediately. Many defenses may be available to you as a borrower, but keep in mind that response deadlines—typically 20 or 30 days after service—are strict. Missing these deadlines can seriously limit your ability to defend against legal action.

Conclusion

Although private student loans can be a resource for financing higher education in certain situations, borrowers should first exhaust all federal financing options and consider private loans only as a last resort.  Private student loans carry higher risks and provide fewer protections, so it’s crucial to thoroughly understand the terms and conditions before committing to any agreement with a private lender.

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  Managing Private Student Loans

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  Determine Your Student Loan Repayment Strategy Tool

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  File a Complaint

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Sources:

[i] Hanson, Melanie. “Student Loan Debt Statistics” EducationData.org, July 15, 2024, https://educationdata.org/student-loan-debt-statistics

[ii] https://ticas.org/wp-content/uploads/2023/12/Private-Student-Loans-Facts-and-Trends.pdf

[iii] Source: Credible

[iv] Source: Federal Student Aid

[v] https://www.occ.treas.gov/publications-and-resources/publications/comptrollers-handbook/files/student-lending/index-student-lending.html

[vi] See, 34 CFR 685.204 (“Deferment”) & 34 CFR 685.05 (“Forbearance”)

[vii] 34 CFR 685.219

[viii] 34 CFR 685.213

[ix] 34 CFR 685.214

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