Federal vs. private student loans: What borrowers should know
Student Loan Servicing Alliance executive director Scott Buchanan explains what to know about repayment plans, budgeting strategies, and how to handle loans in default.
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While student loans offer a grace period for repayment, you will usually eventually have to pay them back. Yeah. All week, we're giving you everything that you need to know about paying back this money. And today, we're breaking down the difference between paying off federal and private student loans. For that, we have Scott Buchanan, who's the Student Loan Servicing Alliance Executive Director. Scott, good to have you here with us. So let's start by explaining the difference between federal and private loans.
Yeah. Thanks, Brad, for having me. Um, yeah, the difference is primarily is who is the lender. Um, federal student loans are lent directly by the federal government using money from Treasury. And private education loans are generally made by banks or other financial institutions, um, using sort of a private credit. Um, they're very similar in private education loans to other consumer credit like credit cards or mortgages or things like that where there are there's a test of credit worthiness, um, that that the lender will make. Um, as opposed to the federal student loan program where generally, it's a federal entitlement, and so if you're going to school have filled out the FAFSA, then you're entitled to get those loans.
How should borrowers approach federal loans?
Listen, federal loans are incredibly flexible in terms of your repayment options. You need to know what kind of loan you have. Do you have a unsubsidized loan? Do you have a plus loan or things like that, um, because they can have different benefits. But there's a lot of options, including forbearances, deferments, income-driven repayment plans, um, that can all dramatically adjust your monthly payment amount. Um, so something you need to always look at is the total balance of your loans and thinking about even when you're in school and thinking about potential repayment, remember you're going to have to borrow the course of two or four years. Um, and think about that in your repayment options.
What about private loans? When should borrowers consider applying for them?
Listen, you should always apply for these loans as early as possible. Once you get your federal financial aid award letter from your institution, talk to the financial aid office. Make sure you've maximized any institutional aid, um, that you can possibly get that would reduce the amount you have to borrow. Figure out how much federal loan ability you have, and then determine what your gap is going to be because the federal loans may not cover all your costs, and that's when you might turn to private education loans. And doing so earlier is better because you can shop around on private education loans and find a lender, um, who's got the best offering for you in terms of an APR, um, and the best sort of program options that are available under that loan.
So what should the plan of attack be for repayment?
Yeah. Well, listen, make a budget like all financial things. Um, you need to know in advance, like that's sort of the advantage of of of, you know, sort of going to school and having this period of time generally when we don't have to make repayment. You have plenty of time to put together sort of what your plan of action is going to be when you graduate and leave. Um, so, you know, number one, don't overborrow in the first place, as I always say. Um, but if you have already borrowed, um, then make sure that you sit down, figure out each monthly payment that you're going to have, the differences between your federal and your private loans because they're going to all have different monthly payments, different interest rates, um, and then put together a budget, a plan of action about how you're going to do it. If, remember, when you first graduate, your income is likely to be a lot lower than it will be in the future, that's when you need to talk to your federal loan servicer and say, hey, here's my financial situation on the federal student loans. How can I lower my monthly payment or how can I meet this this budget that I have today? And they're going to have a lot more options, whereas on the private loan side of things, um, it's going to be relatively set about the monthly payment.
If your loan has gone into default, what are the steps that you should start to take to make sure that you get back into good standing?
Yeah. Well, that's very different between federal and private loans as well. But on the federal student loan, um, once you reach 270 days delinquent, your loan can go into default. And that's when you need to call the Default Resolution Group at the Department of Education. Um, they will reach out and let you know that you're in default, and your servicer will as well. Um, but that's who you need to talk to. There are lots of options, including rehabilitating the loan, potentially consolidating the loan, um, because getting out of default, um, is something that you definitely want to do. And that's why loan rehabilitation would probably be your best bet on federal student loans because that removes that default from your credit history. On private education loans, it's different, and that's why you need to be very mindful about keeping on top of those private education loans because once they go into default and charge off, there's not a whole lot you can do other than sort of negotiate a settlement or potentially a repayment plan, um, to try to resolve the total amount of that debt.
And so once you have finally gotten to the point where you've fully paid off your student loans, then at that point, how are you kind of able to take advantage of other tax advantages as well that you should be making sure that you're also reporting?
Sure, absolutely. Uh, there's a there's a federal interest deduction on on student loans that you can take advantage of potentially. Now, that is tied to income. Um, so, you know, the higher income you are, the less likely are you to be able to take that benefit. But you should definitely during all of your repayment make sure that you're uh that you're uh as you're doing it in TurboTax or working with your accountant, make sure that you calculate the amount of interest that you pay. You'll get a statement from your loan servicer, just like you get W-2s and other things, um, from uh from your employer, and they will tell you how much interest may be eligible, and you should definitely take advantage of that.
Scott, thanks so much for taking the time and breaking this all down.
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