Student Loans: What You Need to Know
16 September, 2021
Applying for college isn’t exactly what you’d call “stress-free.” Unless we count nights agonizing about acceptance letters and future careers as spa days. One day you’re a high school student carried along the current. Then the next day, every adult around you suddenly needs to know what you’ll do with the next 30 years of your life.
Like this, we expect younger people to instantly catch up on the dialogue about college. But few people take the time to break the whole process down. That lack of an explanation turns something like student loans into a higher education boogeyman. While they can be a pretty penny to pay, there are about 42.9 million recipients of student loans. Combined with the constantly rising costs of college, the average person likely can’t escape them.
With that in mind, it’s important to know about the ins and outs of student loans. Because understanding the system will not only prepare you but help you make decisions that work in your favor.
What Are Student Loans?
Student loans are, unfortunately, a necessary evil for many. They provide you with money to attend college when you don’t have enough (and very few do). Then, after borrowing the funds, you pay them back later, along with interest.
This money is separate from any you earn through a grant or scholarship. While schools usually have rules about qualifying for or keeping that type of money, you don’t have to pay it back. It’s a gift.
The unfortunate thing is that college is more expensive than ever before. So, the amount someone needs to take out in student loans for their education has also skyrocketed. But the type of loan you take out can affect the repayment process.
Type of Student Loans
Generally, people talk about the money they borrowed for school under the umbrella term: student loans. But, there are two types based on the lender you borrow from. Here’s how to tell the difference:
Federal Student Loans
The U.S. Department of Education offers federal student loans, but not directly. Instead, other companies, called loan servicers, manage them for the government.
They come with more perks then private loans, making them advantageous. So, it’s generally a good idea to borrow a federal loan first. To start, younger students, like undergraduates, don’t need to go through a credit check to qualify for them. Usually, they’re more affordable, too. They come with a fixed (unchanging) and lower interest rate, making repayment easier on the student.
The key to getting a federal loan is the FAFSA form, or the Free Application for Federal Student Aid. It discusses information like your household income, and the Department of Education uses that to calculate your Expected Family Contribution (EFC). Essentially, it makes an estimate of how much your family can afford.
There are three types of federal student loans:
· Direct unsubsidized loans – These are available to both graduate and undergraduate students, regardless of financial need. With these, you need to pay any interest they build while you’re still in college. Otherwise, it will add to your loan’s principal amount, also called capitalization.
- Direct subsidized loans – Unlike unsubsidized loans, these are only for undergraduates who meet financial need eligibility. You’re not responsible for their interest while you’re still in school (at least half-time), during your grace period, or when your loans go into deferment.
· Direct PLUS loans – Undergraduates can’t apply for these. Instead, PLUS loans are for parents, graduates, and professional students.
Private Student Loans
Private lenders, such as major banks, credit unions, online lenders, state loan agencies, and other financial institutions, offer private student loans. Many parents set up checking or savings accounts for their children before they head out the door. But the bank you’re familiar with may not offer you a student loan. So, you may need to look around for your options.
Private loans don’t require you to file a FAFSA. Instead, you work directly with an individual lender. Because of that, students borrowing from these entities often need a cosigner since they haven’t built up credit yet. However, the good news is that some private lenders only require a soft credit inquiry when you want a quote. So, you can know the possible APR, or annual percentage rate, without it impacting your credit score. The effect only kicks in after you complete the loan application.
Even then, there are other criteria to get approved. For example, you may need to be in a certain year of schooling. So, the lender will only accept you if you’re a senior or a graduate student.
An important note to keep in mind: some private student loan lenders also offer federal student loans. They do this on behalf of the government, but that can make it confusing sometimes. So be careful when doing your research.
How Does Student Loans Interest Work?
From the get-go, your loan comes with a promissory note. You, or your parents if they borrowed for you, sign it. It explains your loan’s terms, such as the amount borrowed, interest charged, interest capitalization, and your payment schedule.
One of the most important parts of that agreement is the interest rate on the loan. Essentially, it’s the cost to take out your loan, based on a percentage of the amount you borrow.
The type of loan you get effects when your interest starts. If you qualify for subsidized federal loans, the government covers your interest while you attend school. That works out well for you because it means the amount you owe won’t grow until you start repaying it.
In contrast, unsubsidized loans start charging interest from the moment money goes into your account, i.e., the day of disbursement. As a result, the balance you need to pay off builds before you graduate.
However, federal student loans’ interest rates won’t change. Once per year, the government sets the new rate, and it stays fixed for the loans disbursed during that time. For example, direct subsidized and unsubsidized loans disbursed on or after July 1st, 2021, and before July 1st, 2022 have a fixed interest rate of 3.73%. There is also:
· Direct unsubsidized loans for graduate and professional students: 5.28%
· Direct PLUS loans: 6.28%
Along with your loan’s disbursement, you also receive an origination fee. Federal loans always include this, and it’s deducted directly from the balance you requested. Here are the rates for the origination fees on loans disbursed after or on October 1st, 2020, and before October 1st, 2022:
· Direct unsubsidized and subsidized loans: 1.057%
· Direct PLUS loans: 4.228%
Private loans are a little different. First, they sometimes skip the origination fee. Although that’s a benefit, they usually have higher interest rates than federal direct student loans. In addition, private loans can have variable rates. Also called adjustable or floating rates, they fluctuate over the life of the loan. They can range between 3.34% to 12.99% when fixed and between 1.04% to 11.98% for variable rates, but private loans ultimately depend on the lender.
How to Get the Best Interest Rates?
Your first step is to do some comparison shopping. You probably want to start your borrowing with a federal loan since they usually have lower interest rates and come with benefits.
Federal loans promise more protections to their borrowers. Like how you get a grace period of six months (or up to nine months for a Perkins Loan) after you leave, graduate, or enroll below half-time. You also have flexibility when it comes time to start your payments.
However, many students and parents have to turn to private lenders once they’ve borrowed the maximum amount they qualify for in federal student loans. So, see what private lenders have to offer in terms of monthly payments, total amount, and interest rates. Many students and parents have to turn to private lenders once they’ve borrowed the maximum amount they qualify for in federal student loans.
If you have to go with a private lender, make sure you either have a strong credit score or find a cosigner who does. That will help you get approved and reduce your rates. It may also open the door to a more flexible repayment plan.
How to Create A Repayment Plan?
When you borrow a federal loan, you start repaying it six months after you drop out, graduate, or attend less than half-time enrollment. PLUS loan borrowers can also wait six months if they are able to defer payment.
Federal loans offer flexibility when it’s time to start paying. You can either go with an income-driven repayment plan or an extended repayment plan. Income-driven means that the student pays the loan based on a percentage of their discretionary income, which is the type of money you set aside for bills or taxes. On the other hand, extended repayment simply requires a fixed, regular monthly payment for a certain number of years.
Repayment plans for private loans depend on the lender. Before you borrow with one, ask about repayment options available to you. Many require you to start while you’re still in school, and the option to defer may help at that time.
One of the ways to simplify repayment is to automate it. Envel’s envelope system makes it easier to set and forget regular expenses like bills or loan costs. All you have to do is enable Autopilot mode and, from there, set up your income and your recurring payments. With that running in the background of your life, all you have to do is make sure enough money is coming in. And in the chaos post-graduation, you could use something that makes your life run smoother.
In the end, student loans don’t have to be your enemy. Remember: they’re helping you reach your goals in higher education. But they can quickly overwhelm you if you don’t know what you’re doing. Take your time to weigh your options carefully before signing off on anything.
But once you work through it – take a breath! College and education are a big deal. You should feel proud of yourself (or your kid) for making it so far.
The great news is that once you grasp how the student loans system works, you don’t have to spend all the time leading up to the school year nervous. You can put that energy to good use – like soaking up the last of summer’s days or planning for your next big adventure.
Ashley KilroyRead more from Ashley Kilroy