Student loans and personal loans might seem similar at first glance, but there are many key differences that all borrowers should understand.
In some cases, a personal loan may be marketed to students making it appear to be a student loan. Borrowers who understand the differences between the two loan types can find better interest rates and avoid repayment headaches.
Student Loans vs Personal Loans Basics
Both personal loans and student loans are usually considered unsecured loans.
An unsecured loan means that there isn’t any asset or collateral attached to the debt. If you fail to make your student loan payments, your lender will not repossess your diploma or the knowledge gained at school. With secured loans, failure to pay means you could lose your house or your car, depending upon the loan.
At the most basic level, a student loan is just a personal loan with some extra rules attached.
The Special Rules for Student Debt
Student loans are treated differently than personal loans in the following ways:
Loan Uses – A personal loan can be used for anything. Students may use student loans for a wide range of educational expenses, but nothing further.
Repayment – With most personal loans, repayment begins immediately. Student loan repayment usually begins after a student finishes school, though some borrowers opt for loans that start repayment from day one.
Bankruptcy – In the United States, most debt is treated the same in bankruptcy courts. However, student loans have special rules that make student debt very difficult to discharge in bankruptcy court.
Interest rates – Student loans often have lower interest rates than personal loans. Several factors influence the interest rates, including the fact that lenders know borrowers are unlikely to erase the debt in bankruptcy. The reduced risk to the lender can mean lower interest rates for the borrower.
How Federal Student Loans Work
Within the category of student loans, there are two main types: federal and private.
At the most basic level, a federal loan is a student loan with some extra benefits.
Two significant features separate federal loans from private student loans:
- Student Loan Forgiveness – While there are many different forms of student loan forgiveness, the options for federal student loans are by far the best.
- Income-Driven Repayment – A unique feature of federal student loans is that borrowers have the option of making payments based upon what they can afford rather than what they owe. Instead of making payments based upon the loan balance, borrowers can select a repayment plan based on their earnings. Some borrowers qualify for $0 per month repayment.
Combining these two features, federal student loan borrowers have protection against unemployment and underemployment. Personal loans and private loans do not provide this protection.
Deciding Between Loan Types
If you are evaluating options to pay for school, the order of preference should look like this:
- Federal Student Loans – Between the forgiveness programs and income-driven repayment plans, borrowers should opt for federal loans even if it means a slightly higher interest rate.
- Private Student Loans – Most students will find that private loans are easier to obtain and have better interest rates than personal loans.
- Personal Loans – Of the three options, personal loans will typically have the highest interest rates and the most strict repayment options. Borrowers seriously considering this option might want to revisit their plan to pay for college.
Personal Loans vs Student Loans in Refinancing
When refinancing student debt, the distinction between a personal loan and a student loan is crucial.
Some lenders advertise student loan refinancing but use personal loans for the refinance process. This is arguably good for borrowers because it means the debt is dischargeable in bankruptcy. However, it also means borrowers lose out on the student loan interest deduction.
In most cases, however, a traditional student loan refinance creates a new student loan.
At present, the following lenders offer the best refinance rates on a traditional student loan refinance:
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