Federal vs. Private Loans

Federal vs. Private Loans

What is the difference between Federal and Private loans?

There are several important differences between private student loans and federal student loans – both in the manner in which they can be obtained and manner in which they can be collected in a borrower defaults.

Private Student Loans

Private student loans are those which are secured through a private lending institution based on the applicant’s credit – much like a mortgage, car loan, or credit card. One major difference between these types of loans is that, in the event of your default, a lender will have to file a timely lawsuit to obtain a judgment against you to try and garnish wages, freeze bank accounts or put liens on your property. The statute of limitations for a private student loan is determined by the underlying promissory note or by the laws of New York State. It is important to note that while some student loans are made by private lenders (such as Sallie Mae), they may have been federally guaranteed nonetheless and thus, like other federal loans, no statute of limitations comes into play.

Federal Student Loans

Federal student loans were historically broken down into two types: Direct Loans and Federal Family Education Loan Programs (FFELP). As of early 2010, however, new legislation has put an end to FFELP loans, thus leaving only Direct Loans. Direct Loans come from the Department of Education (Dept. of Edu.) via the William D. Ford Direct Loan Program. When repayment starts, payments are made directly to the Dept. of Edu. or a loan servicer for the Dept. of Edu. FFELP loans were offered through various private institutions and private guarantors, but the money lent to student was guaranteed by the Dept. of Edu (meaning that if a borrower failed to pay, the private institution would “sell” the loan to the Dept. of Edu. who would use its special powers to attempt to collect the debt). When repayment started, payments were made to the private institution that originated the loan, or its servicers.

There are many types of federal student loans, however, the three most popular are Stafford, PLUS, and Perkins. Stafford loans can be subsidized (the government pays the interest during deferment but not forbearance) or unsubsidized (interest accrues during deferment periods). PLUS loans are those loans borrowed by parents while their child is an undergraduate OR by individuals taking graduate courses. PLUS loan eligibility is the only federal loan based on creditworthiness. Perkins loans are funded through schools directly and upon repayment, paid back to schools directly. Perkins loans are guaranteed by the Dept. of Edu. If a borrower fails to repay this loan, the school will “sell” it to the Dept. of Edu, which will then attempt to collect the loan.

As was previously explained, unlike the vast majority private student loans, there is no statute of limitations for federal student loans.

Collection Tools Available For Defaulted Private Student Loans

When it comes to collections, private student loans are very similar to other unsecured debt obligations. For example, if you default on a private student loan, the creditor can sue you in Court for breach of contract (i.e. failing to make payments in accordance with your promissory note). If the creditor prevails in Court, it will be granted a judgment which will give them the authority to have the borrower’s wages garnished, a restraint placed on the borrower’s bank accounts and/or a lien attached to the borrower’s property.

The biggest differences between a private student loan and any other form of unsecured debt (such as credit card debt, medical bills, or a payday loans) is that private student loans are generally not dischargeable in bankruptcy. Although more rights/powers are available to private student loans, they pale in comparison to federal student loans, which are discussed below.

Collection Tools Available For Defaulted Federal Student Loans

Although federal student loans usually have lower interest rates, better repayment options, etc., they also have greater authority to collect payment when the borrower enters default. For example, collection efforts can range from any of the following for federal loans:

  1. Your loans may be sent to a third party debt collection agency;
  2. You will be liable for the costs associated with collection your loan (including court costs and attorney’s fees);
  3. You can be sued for the entire amount of your loan;
  4. Your disposable income may be garnished up to 15% administratively (i.e. without a lawsuit);
  5. Your federal and state income tax refunds may be intercepted;
  6. The federal government may withhold part of your Social Security benefit payments;
  7. Your defaulted loans will appear on your credit for 7 years;
  8. You won’t receive any additional federal financial aid until certain requirements are met;
  9. You’ll be ineligible for deferments;
  10. Subsidized interest benefits will be denied;
  11. You may not be able to renew a professional license you hold; and
  12. You may be prohibited from enlisting in the Armed Forced.