There are several important practical differences between student loans and credit cards, car loans, mortgages, home equity loans, and home equity lines of credit (HELOC). The type of loan affects eligibility criteria, cosigner requirements, interest rates, deductibility of interest, repayment terms, repayment flexibility, the consequences of default and bankruptcy discharge.
Credit Underwriting Criteria
Eligibility for federal student loans does not involve a credit check.
Federal parent loans do involve a review of the borrower’s credit history, but consider only whether the borrower has an adverse credit history. Eligibility for the Federal Parent PLUS loan, for example, does not depend on credit scores, debt-to-income ratios, duration of employment or minimum income thresholds.
The credit criteria for private student loans, however, are similar to the credit criteria for non-education debt. The borrower’s creditworthiness determines eligibility for the loan and the interest rate paid.
The credit underwriting criteria for private student loans, auto loans, credit cards and mortgages all depend on credit scores, debt-to-income ratios, income and duration of employment. Mortgages may also depend on assets, specifically the source of the funds for the down payment.
Private student loans may also rely on other criteria that are specific to student loans, such as the student’s degree level, year-in-school, and GPA, as well as the college’s cohort default rate.
The maximum debt-to-income ratios for mortgages are generally lower than for private student loans.
Most undergraduate students have a thin or nonexistent credit history. If they have a credit history, it is usually a bad one. This is why many private student loans require the borrower to have a creditworthy cosigner.
More than 90% of private student loans to undergraduate students and more than two-thirds of private student loans to graduate students require a creditworthy cosigner.
In effect, the loan is made on the strength of the cosigner’s credit, not the student’s credit.
The Federal Stafford Loan does not require a cosigner, as eligibility is not based on the borrower’s credit history. The Federal PLUS Loan may require an endorser, which is like a cosigner, if the borrower has an adverse credit history.
Some private student loans offer cosigner release after 12, 24, 36 or 48 consecutive on-time monthly loan payments, but only if the borrower can satisfy credit criteria on their own.
Cosigners are much less common on credit cards, auto loans and mortgages, in part because parents are much less willing to cosign for adult children. Only about one fifth of such loans require a cosigner. Some types of mortgages limit cosigners to parents, grandparents, children, siblings, aunts, uncles, in-laws and spouses.
Otherwise, cosigning an auto loan or mortgage functions much the same as cosigning a student loan. The cosigner is like a co-borrower, equally obligated to repay the debt, and the cosigned loan will appear on the cosigner’s credit history.
The interest rates on federal student loans are fixed. Federal student loans do not currently offer variable interest rates. The same interest rates are offered to all borrowers, regardless of the borrower’s credit scores.
Private student loans may offer fixed or variable interest rates.
The interest rates on private student loans are pegged to the credit scores of the borrower and cosigner (if any), whichever is higher. A higher credit score can yield a lower interest rate. Generally, credit scores are grouped into 4-6 tiers or ranges that are mapped to specific interest rates.
See also: How Does Student Loan Interest Work?
The interest rate on a home equity line of credit (HELOC) is variable. The interest rates on credit cards are usually variable. The interest rates on home equity loans and mortgages may be fixed or variable. The interest rate on an auto loan is usually fixed. Interest rates on mortgages and home equity are generally lower than on private student loans because the loans are secured against default by real estate, while student loans are unsecured.
Some lenders charge points as a way of buying down the interest rate on a mortgage. Most private student loans have zero fees.
Some mortgage lenders offer adjustable-rate mortgages (ARM), where the interest rate is fixed for a number of years and then starts resetting annually (in some cases, monthly). There is nothing similar with student loans.
Most student loans offer an autopay discount, also called an auto-debit discount, where the interest rate is reduced by 0.25% or 0.50% percentage points if the borrower agrees to make the loan payments through an automatic transfer from the borrower’s bank account. Most require electronic billing to qualify for the discount.
Some private student loans offer additional discounts, such as a graduation reward, good grades reward, current customer discounts and on-time payment discounts. Some lenders offer interest rate reductions for borrowers who agree to make interest-only, touch (e.g., $25 per loan per month) or fully amortized payments during the in-school and grace periods.
Some private student loans offer other benefits, such as tutoring, tuition refund insurance, scholarship drawings and a free scholarship search database.
Credit cards, auto loans and mortgages do not offer similar discounts or benefits.
Deductibility of Interest
The student loan interest deduction, on the other hand, still exists. The student loan interest deduction allows borrowers to deduct up to $2,500 in interest paid on federal and private student loans as an above-the-line exclusion from income on their federal income tax returns. They do not need to itemize to claim the student loan interest deduction.
You can no longer deduct the interest on a home equity loan or line of credit if you use the money to pay for college. The interest on a car loan was never deductible.
Federal student loans allow borrowers to switch among several repayment plans at any time throughout the repayment term. These include standard repayment, extended repayment, graduated repayment and income-driven repayment.
Check out our income-driven repayment calculators: Income-Contingent Repayment Calculator (ICR), Income-Based Repayment Calculator (IBR), Pay-As-You-Earn Repayment Calculator (PAYE), and Revised Pay-As-You-Earn Repayment Calculator (REPAYE).
Private student loans mainly offer level repayment plans, but some may offer an initial period of interest-only payments for recent college graduates. Most do not offer income-driven repayment plans.
Private student loans are usually made with a specific repayment term and do not allow borrowers to subsequently change the repayment term. The interest rate on a fixed rate private student loan will usually be lower with a shorter repayment term. Since student loans do not have prepayment penalties, nothing stops a borrower from making extra payments on their loan to pay off the debt quicker. Lenders may have more flexibility on changing the repayment term on a variable-rate loan, since the lender’s cost of funds will float with the interest rate.
Auto loans and mortgages have level repayment plans, just like standard repayment and extended repayment on student loans. You can even use our student loan calculator to calculate the principal and interest portion of your car loan and mortgage payments. (Mortgage payments also include taxes and insurance.)
The length of the repayment term on a car loan is usually shorter than on a student loan, although auto lenders have been offering longer and longer repayment terms as an option.
Credit card debt bases the monthly payment on a percentage of the outstanding credit card balance. This always exceeds the new interest that accrues. This starts off with higher monthly loan payments and gradually decreases as the debt is repaid. Federal student loans offer graduated repayment and income-driven repayment, where the loan payments start off low and gradually increase over time.
Options for Pausing Payments
Student loans provide several options for pausing payments.
Federal student loans and private student loans do not require payments during the in-school period and for 6 months after graduation. Federal student loans can also be deferred during subsequent education, such as graduate school.
After the loan enters repayment status, federal student loans provide an economic hardship deferment, unemployment deferment, military service deferment and forbearances. Private student loans offer full forbearances and partial (interest-only) forbearances.
Federal student loans also offer deferments for active cancer treatment and rehabilitation training programs.
Some private student loan lenders offer an option to put your loans into forbearance to temporarily pause payments. However, interest continues to accrue and is capitalized, meaning it is added to the principal balance of the loan.
Most credit cards, auto loans and mortgages do not offer similar flexibilities. During the coronavirus pandemic, some mortgage lenders are allowing borrowers to pause payments on their mortgages.
Options for Loan Cancellation
All federal student loans and many private student loans offer death and disability discharges of the student loans.
Federal student loans also offer a closed school discharge, identity theft discharge, and an unpaid refund discharge.
Federal student loans offer loan forgiveness to borrowers who work in particular occupations for a specified period of time. These include public service loan forgiveness and teacher loan forgiveness.
Generally, credit cards, auto loans and mortgages do not offer formal loan discharge or loan forgiveness programs. However, there may be separate insurance programs that will pay off a mortgage if the borrower dies or becomes disabled.
It is almost impossible to discharge student loans in bankruptcy, since the U.S. Bankruptcy Code includes an exception to discharge unless repaying the debt will impose an “undue hardship” on the borrower and the borrower’s dependents.
Credit cards, auto loans and mortgages, on the other hand, can be discharged in bankruptcy.
Consequences of Default
Auto loans, mortgages and home equity loans and lines of credit are secured loans. If you default on these loans, the lender can seize your car or home to repay the debt.
Student loans are not secured loans. If you default on a student loan, the lender cannot repossess your education.
This makes student loans higher risk for the lender and therefore higher cost for the borrower.
The federal government has very strong powers to compel repayment of a defaulted federal student loan. These include administrative wage garnishment, intercepting income tax refunds and lottery winnings, offset of Social Security retirement and disability benefit payments, preventing the renewal of a professional license, and blocking eligibility for FHA and VA mortgages.
Private student loans, credit cards, auto loans and mortgages do not have similar powers. However, they may be able to garnish wages after suing the borrower and getting a court judgment against the borrower.
Impact on Credit
Student loans, auto loans and mortgages are all examples of installment loans, which have a similar impact on the borrower’s credit history.
Credit cards and a home equity line of credit (HELOC) are revolving loans, where the amount you owe each month can change.
The amount owed on a revolving loan factors into the borrower’s credit utilization, while the amount owed on an installment loan does not. A low credit utilization can lead to a better credit score, while a high credit utilization can hurt the borrower’s credit score.
Good Debt vs. Bad Debt
Student loans are generally considered to be good debt, because a college education is an investment in the student’s future. Likewise, a mortgage is used to purchase a home, which generally increased in value.
Credit card debt, on the other hand, is usually used for consumption and is not considered to be good debt.