Federal vs. Private Student Loans — The Gap Is Narrowing

Which type of student loans do you have? Are they from a private lender like Discover Financial Services, Wells Fargo or Sallie Mae? Or did they come from the federal government either directly or indirectly? If you got them from the federal government, you are probably in better shape than if they are private loans. This is because private loans tend to be very inflexible. They almost always have fixed terms (the number of years you have repay them) and fixed interest rates.

In comparison federal loans offer a great deal of flexibility. There are six different repayment programs, including what are called Income-driven, and terms ranging from 10 to 25 years. Plus, you could change repayment programs just about any time it made sense and could even consolidate multiple loans into one new one. The type of loan you have pretty much dictates which repayment plans you would be eligible for but all in all, federal student loans offer a variety of options not available with private loans.

The times they are a changin’

In the words of singer-songwriter Bob Dylan the times they are a changin’ for some of you with private loans. Just a few days ago Wells Fargo announced it would reduce the interest rates for certain borrowers starting this month (November). It will also allow borrowers to extend their repayment periods. Since Wells Fargo holds about $11.9 billion in student loans, this change should save borrowers literally thousands of dollars.

Discover Financial Services is putting the finishing touches on its modification program and intends to introduce it early in 2015. It holds roughly $8.3 billion in student loans. Experts say the company is considering a reduction in interest rates and may even forgive the debts of some of its borrowers that can show they are in dire financial straits.

A lot of bad press

Private student loan lenders like banks, credit unions and other such financial institutions tend to get the most flack despite the fact that they hold only 8% of the $1.18 trillion outstanding in student loans. This is due largely to the fact that historically they have been less willing to work with struggling borrowers. As an example of this, federal loans (as noted above) have Income-driven repayment programs where the borrower’s monthly payments are fixed at a percentage of his or her discretionary income. However, this does not extend to private loans. Instead, these borrowers have been at the mercy of the private lenders that, until now, have shown no interest in restructuring their terms or their repayment programs.

The reason for this, the private lenders say, is because they package student loans into securities and then sell them to investors where there are restrictions that make it difficult to adjust the terms for individual borrowers.

However. Wells Fargo has worked with federal regulators to straighten out this problem and found there were no major hurdles or barriers to implementing its new program.

If you can show a financial hardship

Wells Fargo has said that it will consider reducing the interest rates for those of its borrowers that can demonstrate a financial hardship. These people don’t have to be delinquent on their loans to be eligible for this interest rate reduction. In fact, what the bank wants is to hear from are people that are current on their payments but can see a rough time ahead due to the loss of their jobs or some other problem that would damage their ability to repay their loans.

Consolidating multiple private loans

Another advantage that federal student loans have historically had over private loans is that it’s possible to consolidate them into a new federal loan with a better interest rate and a longer term. The way that the interest on one of these Federal Direct Consolidation loans is calculated is by taking the mean average of the loans being consolidated and rounding it up to the nearest 1/8th of 1%. This generally means an interest rate that’s higher than the lowest interest rate on a loan being consolidated but lower than the highest. Just as important, Federal Direct Consolidation loans usually offer the same repayment options as regular federal student loans, including the three income-driven repayment programs.

If you have a good credit score

If you do have multiple private loans you could consolidate them into a new private loan. The main advantage of this is that you would then have just one payment to make a month. When you consolidate multiple loans into a new one it restarts the length of the loan so you would also have more time to repay it, although this means you will pay more interest over the lifetime of the loan. But this could make sense if you have a good credit score because this is what private lenders base their interest rates on. If you’ve gotten out of school, are working and have improved your credit history, it’s possible that your score has improved. If it has gone up by more than 50 points you might be able to get a loan with a better interest rate by consolidating your existing loans with a new lender. You might also talk to the company that currently holds your loans, as it might be willing to lower your interest rate rather than seeing you go to a different lender.

Do you have equity in your home?

If you have equity in your home there is another option. You could get a home equity loan and use it to repay your existing student loans. The benefit of this is that you would have a fixed interest rate and probably a longer term or more years to repay the loan.

Education lenders

There are education lenders where you could get a new loan and consolidate all your private student loans. However, because these are private loans it’s the lender and not the federal government that sets the interest rates. If you are considering a private consolidation loan make sure you determine whether the interest rate is fixed or variable and if you would be required to pay any fees and whether or not the loans you would be consolidating have prepayment fees.

What not to do

If you have a mix of federal and private student loans the one thing you don’t want to do is consolidate them into a new private loan. The reason for this is that you would then lose the benefits of your federal loans such as Graduated Repayment and the three Income-driven repayment programs. This means your best option might be to consolidate your federal student loans into a new Direct Consolidation loan and your private student loans into a new private consolidation loan. While you would have two payments to make a month, you should be able to save money, as you would have lower interest rates on the two loans as well as longer terms. What this boils down to is that if you think consolidating your student loans would make sense, you will need to check your options and then do the math to make sure this would yield a total monthly payment lower than the total of the payments you are currently making. If not, your best bet might be to just to leave well enough alone and concentrate instead on doing everything you can to get your loans paid off as fast as possible.

Here’s a (very) short video courtesy of National Debt Relief with some tips that could help you do just that.