If you're taking out student loans to fund your education, you'll be charged interest. It's the price you pay for borrowing money and it's most often calculated as a percentage of the amount borrowed. Loans with higher interest rates cost more, as do loans with longer repayment timelines because you pay interest over a longer period.
Both federal student loans and private student loans charge interest, although there are some important differences between how it's treated by each of these two loan types.
How does interest work on federal student loans vs. private student loans?
All federal student loans, or loans made by the Department of Education, have common traits when it comes to interest. They all have fixed rates, which means the rate doesn't change during the entire repayment period. And interest isn't determined by any individual borrower's credit profile; it's set on loan type and when the loan was issued.
Private loans work differently. Interest rates are always set based on each borrower's unique credit history and will be lower for borrowers with good credit. Rates could be fixed or variable, with variable rate loans linked to financial indexes and changing over time. Different lenders set their own rates, which can differ substantially from one lender to the next.
FIXED-RATE OR VARIABLE RATE STUDENT LOAN: WHAT IS BEST FOR YOU?
Some federal loans, including Direct Subsidized and Direct Unsubsidized Loans, offer lower interest rates than most private loans and even other federal loans including Grad PLUS or Parent PLUS Loans. But for borrowers with good credit who qualify for private loans at competitive rates, a private loan is often cheaper than a Parent or Graduate PLUS loan -- especially as PLUS Loans charge an origination fee while many private lenders don't.
Direct Subsidized Loans stand apart from all other options, though, because the government covers interest costs on them while payments are paused during periods of deferment. This means no interest accrues while borrowers are in school, during a six-month grace period after graduation before student loan repayment begins, and if borrowers qualify for up to 36 additional months of deferment for reasons ranging from unemployment to military service.
Since interest begins accruing right away on private loans, on PLUS Loans, and on Direct Unsubsidized Loans, Direct Subsidized Loans are always the most affordable alternative. Other loan types shouldn't be considered until these loans have been maxed out.
Is a federal or private loan more affordable?
When deciding between Direct Unsubsidized Loans, PLUS Loans and private loans, you'll want to consider both the interest cost as well as the origination fee, if any, that you'll have to pay upfront to borrow. The table below will help you compare rates.
While interest is important, it's not the only consideration. Federal loans offer important advantages compared with private loans including increased flexibility in repayment plans, income-driven repayment options, and the chance to have loans forgiven for public service work. These benefits are valuable to borrowers who want to serve the public or who worry about their ability to repay their loans.
Borrowers with either federal or private student loans also have the option to lower their interest rate by refinancing their loans with a private lender -- although including federal loans in a refinance loan means giving up their benefits. Still, if you qualify for a refinance loan at a lower rate than you're currently paying, this could make both your monthly payment and the total cost of debt repayment more affordable.