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What are the Downsides and Upsides to Unsubsidized Federal Student Loans?

Mark Kantrowitz

April 23, 2012

As a guidance counselor, I have many families asking me if there’s any downside to taking out a federal unsubsidized loan. They need loan money either way and the rates for the private loans are much higher than the government loans. Most advice sites and articles are very general in nature. Can you provide any specifics on what would be the downsides to accepting a federal student loan vs. a private student loan? — Michelle B.

Generally, students should borrow federal first because federal student loans are cheaper, more available and have better repayment terms than private student loans. But there are a few drawbacks to federal education loans.

Downsides to Federal Education Loans

The most significant downsides to federal education loans occur when a borrower defaults on the loans. The federal government has much stronger powers to compel repayment from defaulted borrowers than do private lenders. For example, the federal government can garnish up to 15% of disposable pay without a court order, while private lenders must get a judgment before they can get a wage garnishment order. (Disposable pay is defined as gross wages minus amounts required by law to be withheld.) The federal government can intercept federal and state income tax refunds, while private lenders cannot. The federal government can garnish up to 15% of Social Security disability and retirement benefit payments, while private lenders cannot. Collection charges of up to 25% of each payment are deducted before the rest of the payment is applied to accrued interest and the principal balance of the debt. The federal government can prevent renewal of a professional license. Borrowers who have defaulted on federal education loans can’t enlist in the military and are ineligible for FHA and VA mortgages.

Another difference between federal and private student loans is the lack of a statute of limitations on federal education loans. Private student loans, on the other hand, are subject to a statute of limitations. The statute of limitations for promissory notes, including those of private student loans, varies from 3 years to 15 years, depending on the state, with 6 years as the most common length of a statute of limitations.

Federal education loans are also not subject to the defense of laches, which argues that a debt is unenforceable because of an unreasonable and harmful delay in demanding payment. Borrowers also have an affirmative obligation to notify the holder of a federal education loan about changes in the borrower’s address.

Federal student loans are not subject to a defense of infancy, unlike private student loans. Accordingly, private student loans require a prospective borrower to have reached the age of majority for his or her state of residence. This is age 18 in most states, except for Alabama and Nebraska, where it is age 19, and Indiana, Mississippi, New York and Puerto Rico, where it is age 21.

Federal education loans, except for the PLUS loan, have lower annual and aggregate loan limits than private student loans. But if a borrower has no choice but to borrow from the federal PLUS or private student loan programs, that may be a sign of over-borrowing.

The federal government is exempt from the Fair Debt Collection Practices Act (FDCPA), unlike the lenders of private student loans. However, any private collection agencies employed by the federal government to collect defaulted federal education loans are subject to the FDCPA.

Private student loans are subject to better disclosure requirements under the Truth in Lending Act (TILA) than federal education loans.


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