Federal vs. private student loans

There are two main categories of student loans: federal student loans and private student loans. As the names imply, federal student loans come through programs backed by the United States Department of Education. In contrast, private student loans come from businesses, including banks, online lenders, and specialized student loan companies.

If you plan to borrow for school, federal student loans are often the best place to get started. These loans come with special features that can cap your monthly payment based on your income and potentially have a portion of your balance forgiven. You don’t get those benefits with private student loans, which work more like an auto loan or mortgage.

To apply for federal student loans, you’ll need to complete the Free Application for Federal Student Aid (FAFSA). For private student loans, you can apply directly through each lender or use an aggregator like Credible to check your rate for multiple private student lenders at once.

Federal student loan benefits

When you take out a private student loan, lenders look at your credit history and finances when making lending decisions. With federal student loans, you may have an easier time getting approved and more flexibility in how you pay back your loans. These are some of the biggest benefits of federal student loans compared to private student loans:

• Easy to qualify: Federal student loans are available to most permanent U.S. residents. Most federal loans don’t require any type of credit check, though some require demonstrating financial need. You don’t need a specific credit score or a cosigner for federal student loans.
• Low interest rates: The federal government sets rates for federal student loans. For the 2020-2021 school year, rates are 2.75% for undergraduate borrowers.
• Income-based repayment plans: Federal loans come with a range of income-based repayment plans that lower your monthly payment based on your income. If you stick with the plan long enough, your remaining balance may be forgiven.
• Loan forgiveness: There are several programs available that lead to loan forgiveness, notably for public employees and borrowers who make payments on an income-based repayment plan for 20 or 25 years, depending on the repayment plan you choose.
• Deferment and forbearance: If you go back to school, join the military, or cannot repay your loans, you could qualify to pause your payments temporarily. With federal student loan deferment, interest generally won’t accrue while payments are paused. With forbearance, your balance may continue to grow while you’re not paying.

If you’re worried about short-term cash flow, earned wage access from PayActiv is an essential tool for your finances. With earned wage access, you can get access to your earned but unpaid wages before payday. When you have student loan payments due, that can be an important financial lifeline.

How student loan interest works

Most federal student loans follow a 10-year repayment plan. Interest is charged monthly, and payments first apply to interest and then principal.

The math used to calculate payments over the life of the loan is referred to as amortization. With an amortization schedule, you can see how a fixed monthly payment leads to a $0 balance when the final payment is made.

Again, the power of earned wage access can be helpful. . The reason is that if you are able to make a payment early, even by just a day or two, it reduces the interest you pay over the life of the loan.

Let’s look at an example loan. Let’s say you have a $20,000 federal student loan balance with a 2.75% interest rate (we divide this by 12 to get a monthly rate) and a $125 monthly payment.

On this date, with a $20,000 balance, monthly interest would be charged like this:

$20,000 x 2.75%/12 = $20,000 x .002292 = $45.83

When paying $125, the first $45.83 would go to interest while the remaining $79.17 would lower the $20,000 balance to $19,020.83. Next month, interest would be a little less, and the contribution toward the loan’s principal balance would be higher.

You may want to pay extra if you can afford it. A larger payment puts more toward lowering the principal, which lowers your interest cost every month going forward. The faster you pay off your loans, the more you save on interest costs. That’s where earned wage access from PayActiv can help you.

Learn more: How the PayActiv Financial Wellness Platform Can Help You Manage Your Finances

Taking charge of student loan debt

If you’re having trouble with a student loan payment, don’t forget about your ability to access your earned wages through a partnership between your employer and PayActiv. In addition to earned wage access, PayActiv members can utilize free financial planning sessions and money management tools, all designed to keep your finances on track.