How Student Loans Work: Federal First, Then Private

Two loans can both be called a “student loan” and run on completely different rules. One is made by the federal government, with terms written into law. The other is made by a bank, credit union or online lender, with terms set by that company and your credit. Borrow in the wrong order and you can give up protections you never knew you had — so the order is the first thing to get right.

Here is the read: exhaust free money and federal loans first, then use a private loan only to cover what’s left. The rest of this guide is why.

Federal loans: terms set by law, not by a sales desk

Federal student loans start with one form, the FAFSA, which also opens the door to grants and work-study you never repay. The loans themselves carry a fixed interest rate set by Congress each year — the same rate for every borrower, regardless of credit — and a set of protections that travel with the loan:

• Income-driven repayment. If your income is low relative to what you owe, your payment can be tied to what you earn rather than what you borrowed. See repayment options.
• Deferment and forbearance. Formal ways to pause payments during hardship, unemployment or a return to school, without defaulting.
• Forgiveness paths. Programs for public-service workers and for balances that remain after decades of income-driven payments.
• A grace period. Most federal loans don’t require payments until about six months after you leave school. See grace period.

Undergraduate federal loans also come in a subsidized form for students with financial need, where the government covers the interest while you’re in school. That’s money you simply don’t pay. No private loan does this.

Federal loans have a catch worth naming: annual and lifetime borrowing limits. For many students those limits don’t cover the full bill, which is exactly where private loans enter.

Private loans: a bank loan that happens to be for school

A private student loan is underwritten like any other consumer loan. The lender checks credit and income — usually the parent’s or a cosigner’s, since most students have thin files — and sets a rate and terms accordingly. That produces three differences that matter:

• The rate depends on you. Strong credit can beat the federal rate; weak or no credit can land well above it. It may also be variable, meaning it can climb.
• The protections are the lender’s call, not the law’s. Income-driven repayment, broad forgiveness and generous hardship pauses generally don’t exist. What you get is whatever the contract says.
• A cosigner is usually on the hook. That person is equally responsible for the full balance, and it affects their credit too. We cover what that means in cosigners and private loans.

None of that makes a private loan a trap. It makes it a tool for the gap between your costs and everything you don’t have to borrow privately: scholarships, grants, savings, and federal loans.

The order that saves you the most

Work down this list and stop as soon as the bill is covered:

1. Money you don’t repay. Scholarships, grants, and work-study, opened up by the FAFSA.
2. Subsidized federal loans, if you qualify — the government pays the in-school interest.
3. Unsubsidized federal loans, up to your limit, for the fixed rate and the federal protections.
4. A private loan for the remainder, compared across a few lenders by APR, not the teaser rate.

The reason to follow it in order isn’t loyalty to any lender. It’s that each step down trades away something you can’t easily get back — free money, then subsidized interest, then federal protections.

Borrow the number you need, not the number offered

Aid offers and credit limits tend to arrive larger than the actual gap. Every extra dollar is a dollar plus interest you repay after graduation, often for ten years or more. Before you accept any loan, run the likely payment against a realistic starting salary in the affordability explorer, and size the loan to the bill rather than the offer.

Where to go next

If a private loan is in the picture, read what a cosigner takes on before anyone signs. If you already have loans, the repayment options guide shows how to pick a plan, and refinancing student loans covers the one move that can quietly cost federal borrowers their protections. For the official source on amounts, rates and forms, start at studentaid.gov.