Should I Pay Off Private Or Federal Student Loans First

Q: If I have both private and federal student loans, and have the ability to pay off a few student loans completely, should I pay off the private student loans or the federal student loans (which are both around the same interest rate)?

A: Even though the interest rates on private student loans and federal student loans can be similar for some borrowers, keep in mind the interest rates on private student loans are variable, meaning they can fluctuate. Though interest rates are important, when it comes to student loans, borrowers have many more repayment options and programs with federal student loans. It may seem to make more sense in the short-term to pay off the federal student loans, if they are at a higher interest rate than the private student loans, however in the long-term, paying off the private student loans may prove to be more beneficial.

Private student loans, unlike federal student loans, have very limited options when it comes to repayment and/or flexibility in terms. Should you fall upon hard financial times in the future and are unable to make your student loan payments, you will have very few options with private student loans. If you are unable to make the monthly private student loan payments, this could lead to your credit being damaged or much worse. With federal student loans you have more options, flexibility, and security when it comes to repayment. As with all financial decisions, consulting one-on-one with a financial professional who can assist you with your specific financial situation is recommended.

This is a common dilemma for many borrowers juggling both private and federal student loans. On the surface, it might seem like paying off the loan with the highest interest rate is the smartest move. However, there are several factors to consider beyond just interest rates—especially when comparing private loans to federal loans. Let’s break it down so you can make an informed decision.

Step 1: Understand the Interest Rate Situation

Interest rates matter, but they aren’t the only factor in this equation. While it’s true that federal student loans tend to have fixed interest rates, many private student loans come with variable rates that can change over time. So, while both loans may appear to have the same interest rate right now, the private loan interest rate could increase in the future, which could lead to you paying more over time.

Pro Tip: If you’re dealing with private student loans that have variable interest rates, keep an eye on any potential increases. Federal loans, on the other hand, stay locked in at their fixed rates.

Step 2: Consider the Repayment Flexibility

Here’s where things get really important: federal student loans offer a ton of flexibility. Whether it’s income-driven repayment plans, deferment options, or even forgiveness programs, federal loans give you multiple avenues for managing your debt if times get tough. Private loans, in contrast, typically don’t come with any of these benefits. If you miss a payment or fall on hard times, private loan lenders might not be as forgiving, and you could face penalties, a damaged credit score, or even legal action in extreme cases.

“When it comes to flexibility, federal student loans are the clear winner. They’re designed to help you, not trap you.”

Step 3: The Security Factor

Another big reason to prioritize paying off your private loans first is the security that federal loans provide. Federal student loans are backed by the government, meaning you have a safety net if you face financial difficulties. You can apply for deferment, forbearance, or even see some of the loans forgiven after a set period (if you qualify). Private loans, however, are much riskier, as they are not backed by the government, and lenders have far less flexibility when it comes to working with you.

Pro Tip: If you’re unsure about the flexibility of your private loans, contact your lenders to find out exactly what repayment options they offer in case of financial hardship.

Step 4: Impact on Your Credit

When you’re deciding which loans to pay off, it’s also important to think about your credit. Both private and federal student loans can affect your credit score if you miss payments, but the repercussions can be more severe with private loans. Private lenders are typically quicker to report missed payments, which can cause a sharp dip in your credit score. In contrast, federal student loans have more options for keeping your credit intact if you’re struggling to make payments. For example, federal student loans allow you to apply for deferment or an income-driven repayment plan to avoid default.

Step 5: Long-Term Strategy

In the long run, paying off your private loans first may be the smarter financial move. While both types of loans may have similar interest rates, the higher flexibility and repayment options of federal loans could save you more money in the future. By paying off private loans first, you can eliminate your most risky debt. This is especially true if you foresee needing financial flexibility down the road, such as job loss or changes in your income.

Pro Tip: If you anticipate needing repayment flexibility in the future, prioritizing private loans first could give you peace of mind. Federal loans can always be tackled later, once your riskier debt is out of the way.

Step 6: Consult a Financial Advisor

Finally, before making any big financial decision, especially one that could impact your credit and future financial flexibility, it’s wise to consult a financial advisor. A professional can help you understand the full scope of your financial situation, including whether consolidating your loans, refinancing, or tackling a specific loan first makes sense for your unique goals. Sometimes, the numbers don’t tell the full story, and expert advice can offer invaluable clarity.

“You don’t have to figure this out alone. A financial advisor can offer tailored advice that aligns with your specific goals and financial situation.”

To sum it all up, paying off private student loans first often makes more sense, even if the interest rates are similar to federal loans. Private loans are riskier, with fewer options for flexibility, which means you’re better off clearing them out first. That said, federal student loans still offer much-needed security and repayment options, so they should not be ignored. Whatever you decide, make sure you understand all your options and consider speaking with a financial professional to make the best decision for your future.