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.
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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.
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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
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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