State school or private school, borrowing is almost unavoidable for American students looking to finance a four-year college degree. In 2008, more than 65% of graduating students left campus with an average student loan debt of $23,000.

The student loan process can be confusing and sometimes frustrating. Complicating things is the fact that two types of loans exist: federal and private. Students and parents often don’t understand the differences. If you’re trying to choose a college loan, here’s what you need to know:

Federal loans can involve private lenders
There are currently two federal loan programs: the Federal Family Education Loan Program (FFELP), whereby loans are issued by a private lender, insured by the federal government in case of borrower default, and the Federal Direct Loan Program (DL), whereby loans are issued directly by the federal government.

Both types are considered "federal" loans, even though the FFELP involves private lenders. Within both FFELP and DL, there are Stafford loans for undergraduates and graduates; Grad PLUS loans for graduates (which can be taken in addition to Stafford); and Parent PLUS loans. (A third type of federal loan, the Perkins, is supplied by the government and administered through colleges.)

Nearly identical terms, but different levels of support
From the borrower’s perspective, there are no substantial differences between FFELP and DL loan terms. Both require the Free Application for Federal Student Aid (FAFSA) annually; both require no credit check; both have the same annual caps on the amount you can borrow; both have nearly the same interest rate set by Congress (Parent PLUS loans in the FFELP have a slightly higher rate than in DL); and both offer practically the same repayment options, with some very slight variation.

FFELP borrowers typically receive additional debt management support and counseling from federally funded nonprofits, such as American Student Assistance, that service FFELP but not DL. So how do you choose a federal loan program? Well, you, the borrower, don’t; typically, individual colleges select which program to participate in (a small amount of schools offer both). 

Federal loans should be your first choice
Undergraduate and graduate students should always explore federal student loans, whether FFELP or DL, as their first financing option after grants and scholarships have been exhausted. Federal loans have lower, fixed interest rates and much more flexible repayment options than do private loans.

Parents should know about Federal Parent PLUS but should look into all options. Depending on the family’s circumstances and availability, taking out a home equity loan instead of the PLUS can be advantageous. Also, some state nonprofit lenders offer private parent loans with competitive interest rates that are lower than the PLUS.

Private Loans

If you cannot meet all of your educational expenses through federal loans, private loans are another option. But you must understand the requirements and repayment terms before going with this financing alternative:

• These loans may have no limit on how much you can borrow and can be made directly to the borrower without the certification of the school and no FAFSA required. Be sure to limit your borrowing to only what you need for school, as no one (other than yourself!) may be keeping track of your cumulative loan balance.
• Interest rates are usually higher than federal loans and are variable.
• The student is typically the borrower with the parent as co-signer if required (eligibility based on credit criteria - usually your credit score). Beginning last year during the credit crunch, private student loans now require much higher credit scores than in previous years. Additionally, whereas any student who is eligible for a federal loan will receive one regardless of institution attended, some lenders have opted not to give private loans to "riskier" borrowers who have poor credit or attend certain types of schools, like community colleges or vocational schools.

Only use private loans as a last resort
Given the riskier nature of private loans, students and parents should always choose to tackle the FAFSA for a federal loan, however Herculean that task seems. But what if you still have need after taking out federal loans?  Private student loans can be used to fill the gap. Talk to your financial aid office; Conduct your own research; And, approach the situation as a consumer. Know what you’re getting in to and think about the financial reality of your repayment budget after school. 

So, what about repayment?

Ah, yes, paying back the loan...everybody's got to do it. And it's very important to know all of your options.

With Federal Stafford and Grad PLUS loans, repayment begins six months after you graduate or drop below half-time (called the “grace period”). In some cases, interest is paid by the federal government while you are in school and during grace and deferment periods. Deferment allows you, under certain conditions, to postpone payment temporarily.  Parent PLUS loans require payment immediately upon disbursement, although the parent can choose to defer payment until the student graduates or drops below half-time. 

Actual Stafford and PLUS repayment plans range from a standard 10-year payment term, to lowering monthly payments through an extended payment term, to consolidating your student loans, to basing monthly payment on your income, or starting off with smaller payments that gradually rise as your income grows. Some repayment options will increase the total amount of interest paid over the life of the loan; borrowers should always consult their student loan service provider for details.

With private student loans, you typically do not have to repay until you drop below half-time, although some loans now require you to make interest-only payments while in school and then begin principal and interest six months after graduating or leaving school. These loans do not have the repayment options that are available with federal loans, such as deferments, forbearance, or income-sensitive repayment.  Also, you cannot consolidate your federal and private loan debt. While private loans do not afford as many repayment options as federal, if you’re having difficulty managing your private loan debt, you should contact the holder of your loan to discuss the situation.  Defaulting on your loan is a lose-lose for both you and the lender.

What if I already have student loans but don’t know if they’re federal or private?

If you haven’t kept track of all your loan paperwork over the years, you have a few options:

• Visit nslds.ed.gov.  This is the National Student Loan Data System and it will list all of your federal loan amounts, lenders, servicers (the company that collects payment) and, when applicable, guarantors (the nonprofit debt management counselors referred to above)
• Contact your school’s financial aid office, which will have records of all your federal loans and in some cases your private (but as discussed above, some private loans are made directly to the borrower, with no school intervention).
• Request a free copy of your credit report from one of the major credit bureaus.

What's the bottom line? Student loans are becoming an increasingly vital component for financing higher education in the United States today. The federal government has created a comprehensive loan program (including Stafford, Perkins and PLUS loans) to help students and their families afford their education and this should be every student's first choice in financing. This program offers lower interest rates based on a federal formula (not a person's credit score) and has the most repayment flexibility.