Financial Aid

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

Mark Kantrowitz

April 23, 2012

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

Federal Education Loans Offer More Options for Financial Relief

Federal education loans offer economic hardship deferments for up to 3 years and forbearances for up to 5 years, while private student loans typically offer forbearances for at most one year, and may charge a quarterly fee per loan for a forbearance. The federal government pays the interest on subsidized federal Stafford loans and federal Perkins loans while the student is enrolled in school (and in some cases, during the 6 or 9 month grace period after graduation). The federal government also pays the interest on subsidized loans during the economic hardship deferment. Federal student loans offer income-based repayment and public service loan forgiveness; private student loans and federal Parent PLUS loans do not. All or part of the interest on subsidized loans may be paid by the federal government during the first three years of income-based repayment. Federal student loans also offer a variety of up-front teacher loan forgiveness programs and forgiveness for military service. Federal education loans also offer other flexible repayment terms, such as graduated repayment and extended repayment. Federal education loans provide for a death and disability discharge if the borrower (or in the case of a federal Parent PLUS loan, the student on whose behalf the parent borrowed) dies or becomes totally and permanently disabled. Four private lenders — Sallie Mae, NY HESC, Discover and Wells Fargo — offer similar benefits, but other private student loan programs do not. Federal education loans include discharges for identity theft, false certification of ability to benefit, unpaid refunds and closed schools in certain circumstances.

Differences Between Education Loans and Other Types of Consumer Credit

Other aspects of both federal and private student loans distinguish them from other forms of consumer credit. Some of these differences are beneficial and some are not. Federal education loans offer a 0.25% interest rate reduction for borrowers who repay their loans through automatic monthly direct debit from a checking or savings account. Most private student loans offer a similar interest rate reduction, typically either 0.25% or 0.50%. Most other forms of consumer credit do not offer auto-debit discounts. Federal and private education loans cannot be discharged in bankruptcy unless the borrower demonstrates undue hardship in an adversarial proceeding. This is a very difficult standard, requiring a "certainty of hopelessness" in the words of one bankruptcy judge. Borrowers are more likely to die of cancer or in a car accident than to get their loans discharged in bankruptcy. Credit card debt and other types of consumer debt can be discharged in bankruptcy. Both federal and private student loans are unsecured. If you default on a home equity loan, you can lose your home. But if you default on a student loan, the lender can't repossess your education. Borrowers of federal and student loans can defer repayment while the student is in school and for a 6 or 9 month grace period after graduation. (Interest continues to accrue during the deferment. If the borrower does not pay the interest as it accrues, the interest is capitalized at the end of the deferment, increasing the size of the loan.) Home equity loans, mortgages, auto loans and credit cards do not offer similar flexibility to delay the start of repayment.

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