Types of student loans: A comprehensive guide

Whether you’re a first-year collegian, a seasoned student or a parent, student loans can help you pay for the high cost of college. In fact, more than 6 in 10 college students with an undergraduate degree or certificate used federal student (or parent) loans to cover educational expenses, according to National Center for Education Statistics data.

However, taking on education debt isn’t a binary choice — there are different types of student loans, including federal and private loans, each with unique pros and cons. The types of federal student loans, for example, cater to certain groups, such as subsidized loans for lower-income families and loans in larger amounts for graduate students and parents. Meanwhile, private loans may be useful for students (and parents) who have exhausted their federal loan allotment, have excellent credit or are pursuing nontraditional education programs.

Understanding the types of federal loans available, plus private forms of education debt, can help you determine which loans are right for you and your family.

The main types of student loans: Federal and private

The US Department of Education offers four types of federal student loans, while private loans are offered by financial institutions, such as banks, credit unions and online lenders.

Here’s a quick summary of the differences between the two options:

What are the four types of federal student loans?

Each of the four federal loan types is designed for certain types of students and their parents. For example, undergraduates may qualify for subsidized or unsubsidized loans, and graduate and professional students can choose between unsubsidized and PLUS loans.

Here’s a quick summary of what’s available:

1. Direct Subsidized Loans

Best if you’re an undergraduate student with financial need.

With these loans, the federal government pays the interest that accrues on your loans while you’re in school with at least half-time enrollment, during the six-month grace period after you leave campus and during future deferment periods. That said, there are limits to how much you can borrow each year — $3,500 to $5,500, depending on your year in school.

2. Direct Unsubsidized Loans

Best if you’re an undergraduate, graduate or professional student.

While they don’t come with interest subsidies, Direct Unsubsidized Loans offer relatively low interest rates, and there’s no credit check when you apply. However, there are limits to how much you can borrow each year — $5,500 to $7,500 for dependent undergrads ($9,500 to $12,500 for independent undergrads), depending on your year in school, and up to $20,500 for graduate students.

3. Direct PLUS Loans

Best if you’re a graduate or professional student with higher borrowing needs or a parent.

Direct PLUS loans offer more flexibility than Direct Unsubsidized Loans because they allow you to borrow up to the cost of attendance for your school (minus other financial aid received). They’re also the only federal loan option for parents.

However, PLUS Loans require a credit check when you apply. While there’s no minimum credit score requirement, you may be denied if you have certain adverse items on your credit reports, such as delinquent debt (over 90 days late), tax liens, foreclosure or bankruptcy debt discharge.

4. Direct Consolidation Loans

Best if you’re no longer a full-time student and want to simplify your loan repayment or access certain benefits.

If you have multiple federal student loans, the Direct Loan Consolidation program allows you to combine them into one monthly payment. Additionally, certain programs, such as student loan forgiveness and the Income-Contingent Repayment Plan for parents, may require you to consolidate your loans to qualify.

Unlike private student loan refinancing, however, federal consolidation won’t give you the chance to secure a lower interest rate. In fact, your new rate will be the weighted average rate of the loans you’re consolidating, rounded up.

What are the four types of private student loans?

Private student loans are offered by banks, credit unions, online companies, state-sponsored agencies and other financial institutions instead of the federal government. Types of student loans, repayment terms, interest rates and other features can vary widely by lender.

What’s more, private loans require a credit check, and your eligibility and loan terms will depend on your creditworthiness. If you have a thin credit file or a checkered credit history, applying with a creditworthy cosigner (such as a family member) can help — though there are also no-cosigner student loans available, too.

The four types of student loans via private lenders include:

1. Undergraduate student loans

Best if you’re an undergrad, you’ve exceeded your allotment of federal loans and you have a parent who can cosign your loan application.

Because many undergraduate students haven’t had the chance to build a credit history, you’ll likely need a cosigner to get approved. That said, private undergraduate loans may offer higher loan limits than the federal student loan program, which can help you in the event that federal loans aren’t enough.

2. Graduate student loans

Best if you’re a grad student, you have a creditworthy cosigner and you can qualify for a lower interest rate than the federal Grad PLUS loan rate.

Many private lenders offer standard graduate student loans, but some may offer specialized loans for certain types of graduate programs, such as an MBA, law school and medical school. You may even find a loan for a residency program or bar exam study. But as with undergraduate loans, graduate loans may require a cosigner unless you’re working full-time and have great credit.

3. Parent loans

Best if you’re mom or dad but don’t qualify for federal Parent PLUS Loans.

With excellent credit, parents may even qualify for a lower interest rate than what they’d pay with a federal Parent PLUS Loan. But unlike Parent PLUS Loans, private parent loans don’t come with an income-driven repayment plan or generous forbearance and deferment options.

Tip for parents: If you borrow a private or federal loan on behalf of your student but want them to ultimately be responsible for repayment, you may be able to refinance the loan into their name after they leave school. While some of the best student loan refinance companies offer this option, the federal government doesn’t. (As always, before refinancing federal loans, make sure that you’re willing to forfeit government-exclusive repayment protections.)

4. Income-share agreements

Best if you’re a student with an insufficient credit history and no cosigner to help you access traditional private loans.

Income-share agreements (ISA) don’t charge interest like traditional student loans, but they are loans despite their name. The borrower agrees to “share” a percentage of their post-graduation earnings — often between 2% and 10% — with the ISA lender for a period of two to 10 years.

There’s no credit check, and there are caps on how much of your income you’ll pay. But without a clear idea of how much income you’ll earn, you may be at risk of paying far more with an ISA than you would with another type of student loan.

“The ISA provider is taking on more risk compared to a loan, so they typically need to charge a higher rate to compensate for that,” said Dror Liebenthal, CEO of Bold.org, a scholarship search engine.

Which type of student loan should you choose?

Before you even think about borrowing money for school, look to sources that don’t require repayment.

“Students should first focus on funding their education through income, scholarships, support from family, if available, and lower-cost schools before considering loans,” said Liebenthal.

If you’ve exhausted those options and still need to borrow, start with federal student loans. With standardized interest rates, college students and their parents don’t have to worry about being penalized for not having stellar credit. And, even if you have great credit, private student loans don’t offer the same relief options for struggling borrowers as federal loans.

“As we saw with the CARES Act, borrowers were given consideration for their federal loans and were able to pause their payments for over three years — private and other types of loan programs didn’t get that,” said Stacey MacPhetres, senior director of education finance at Bright Horizons Family Solutions, which partners with employers to offer education benefits.

If you reach your borrowing limit for federal loans and there’s still a gap between your funding and expenses, private loans can help cover the remaining amount.

OK, but how do I apply for these loans?

To apply for federal student loans, fill out the Federal Application for Federal Student Aid (FAFSA) annually. The form asks questions about your and your family’s financial situation. Then, you’ll receive a financial aid award letter from your school detailing what you qualify for, including loans, grants and work-study opportunities.

To apply for private student loans, start by researching and comparing the best private loan options available. You can typically get pre-qualified with a soft credit check, which won’t hurt your (cosigner’s) credit scores, and view rate quotes and other potential loan terms. Once you’ve determined which lender is right for you, you’ll submit an application to your preferred lender.

Pros and cons of federal student loans

Federal student loans offer an opportunity to finance your education without worrying about a credit check or high interest rates. They also come with low fixed interest rates that don’t fluctuate over the life of the loan, and repayment terms are flexible. You can change your repayment plan for free, simply by calling your assigned servicer. There are even relief options if you experience financial difficulties, including the new SAVE plan.

However, federal student loans typically come with an upfront fee deducted from your loan proceeds. If you’re attending an expensive school, you may also run into annual and lifetime limits with Direct Subsidized and Unsubsidized Loans. While standardized rates can be good if you don’t have a strong credit history, parents and graduate students may be able to secure a lower rate with a private lender.

Pros and cons of private student loans

If you’re applying for a private student loan, you can choose from a long list of lenders. You typically don’t have to worry about upfront fees, and some private lenders are also willing to work with part-time students who don’t meet the half-time enrollment requirement for federal loans. If you’re a graduate student or parent with great credit, you could qualify for a lower rate compared to Direct PLUS Loans.

That said, interest rates can be high for less-qualified borrowers, and students and parents with less-than-stellar credit may not be eligible at all. There’s also limited flexibility with your repayment options after you choose your term, and while many lenders offer deferment or forbearance, it’s not nearly as generous as the federal government.