When evaluating student loan options, the interest rate is often the deciding factor. For many, the lower the rate, the better the loan.
However, this simplistic method of evaluation fails when comparing federal student loans to private loans. In many cases, a federal loan –even one with a higher interest rate– is preferable to a private loan.
The preference for federal loans is best explained by taking a close look at some of the more favorable terms of federal loans. In many cases, these federal benefits are worth living with a higher interest rate.
Income-Driven Repayment Plans like IBR, PAYE, and REPAYE
One feature unique to federal student loans is that borrowers have the option of making payments based upon what they can afford. Borrowers who are struggling financially may qualify for $0 per month payments.
In nearly all other forms of consumer debt, the monthly payments are based upon how much a borrower owes. Unemployed borrowers don’t have the option of suspending mortgage, auto, and credit card payments year after year.
Income-driven payment calculations are far from perfect. The government calculations for “discretionary” income ignore factors like medical bills, child support, and mortgage payments. Despite these flaws, income-driven repayment plans still provide great protections to borrowers who find themselves unemployed or underemployed.
Another massive benefit to Income-Driven Repayment is that borrowers can qualify for student loan forgiveness.
Student Loan Forgiveness
Arguably the most significant perk of federal student loans is student loan forgiveness.
The fastest route to student loan forgiveness is Public Service Student Loan Forgiveness (PSLF). Borrowers who work for the government or an eligible non-profit can qualify for PSLF after ten years worth of eligible student loan payments.
Borrowers in the private sector can have their debt forgiven after 20 to 25 years on an income-driven repayment plan. While two decades worth of payments may seem like an eternity, it provides a viable path to debt freedom for many borrowers.
Tax Consequences of Student Loan Forgiveness:Borrowers who qualify for forgiveness under PSLF do not have to pay any taxes on the forgiven debt. However, borrowers who qualify for forgiveness under an income-driven repayment plan may face a large tax bill.
Protection for the Unexpected
While PSLF and IDR forgiveness get most of the attention, there are other avenues for federal student debt to be discharged.
If the borrower dies, the debt is forgiven. Similarly, Parent PLUS loans can need if the student for whom the loan was borrowed passes away. Some private lenders may forgive debt under this circumstance, but many will try to collect the remaining balance from the borrower’s estate or cosigner.
Additional protection exists if a borrower becomes permanently disabled. Most borrowers don’t consider what will happen with their student loans if they are permanently unable to work, but federal student loan borrowers can have their student debt forgiven.
Finally, some students face hardships because their school shut its doors. In some cases, the debt may be discharged because of a school closure. The federal government tracks school closures and provides students with a list of resources.
Most borrowers don’t plan for tragedy or unexpected hardship, but these protections provide a meaningful benefit to federal student loan borrowers.
Federal Law Changes and New Government Programs
Over the years, the federal government has modified the rules in order to help borrowers manage their loans.
Candidates for office often advocate student loan changes to help borrowers. In most cases, these changes would only help those with federal student loans.
One notable example was the creation of the REPAYE plan. At the time it was created, many borrowers with existing loans had to pay 15% of their discretionary income towards their federal loans. When REPAYE was created, many of these borrowers were able to get their monthly payments lowered to 10% of their discretionary income.
Another example of a helpful change came during the Coronavirus pandemic. When Covid-19 brought the economy to a stop, federal student loan interest and payments were suspended. Private lenders were able to provide limited support to some borrowers, but the borrowers with federal student loans were the only ones who saw interest rates set to 0%.
There has also been discussion of federal student debt cancellation, notably from presidential candidates Elizabeth Warren and Bernie Sanders. It is possible that at some point, a candidate will be elected with a pledge to eliminate existing student debt. Such an event appears very unlikely at present, but the possibility that it could happen in the future is a perk to federal student loans.
Multiple Repayment Plan Options
Many private loans come with a set repayment schedule. Some borrowers are willing to live with larger payments, so they opt for a shorter repayment plan to get a lower interest rate. Other borrowers need the lowest payment possible, so they sign up for loans with higher interest rates, but longer repayment schedules.
The problem with many private loans is that the repayment length is fixed, and monthly payments are not flexible.
In the world of federal student loans, borrowers are free to bounce around different repayment plans.
In fact, there are so many different federal repayment plans that many borrowers and advocates complain that the multitude of options is confusing. However, the borrowers who take time to research the various repayment plans can usually find an option that suits their unique needs. As their circumstances evolve, federal borrowers can switch from one plan to the next as needed.
Private Benefits Can Be Utilized Later
Despite the wide range of federal student loan perks, there are times when selecting a private loan is the best choice. This circumstance normally occurs for the borrowers who have a steady income and make the determination that they will almost certainly be paying their debt off in full.
These borrowers want the lowest interest rate possible and don’t have a need for the various perks and protections afforded by federal loans.
In this situation, borrowers can refinance their federal debt with a private lender. By opting for a private refinance, borrowers can get rates as low as 2%.
Thus, the ideal strategy for most borrowers is to opt for federal loans and keep the loans with the federal government as long as the protections are valuable. Once the perks are not worth the higher interest rate, switch to a private loan via refinance lenders like SoFi or Splash.