Student Loans & What You Need To Know About Them Before You Borrow Money For Your Education
I know I sound like a broken record at this point — COLLEGE IS EXPENSIVE. I will say it over and over because it is TRUE. The cost of a college education has gone up exponentially over the past few decades, and it shows no signs of slowing down. The cost of tuition and room and board continues to increase, and many students rely on student loans to help them obtain their college degrees.
If you plan to go on to obtain a secondary education after high school and know you will need to borrow money to pay for college, make sure you know what types of financial support and student loans are available and how they work.
Before signing up for student loans
Before you line up student loans to help you pay for college, there are some other steps you’ll need to take first. The first step in this process is to fill out the FAFSA (Free Application for Federal Student Aid). You’ll fill out the FAFSA every year before starting another year of college, and the government will use this application to tell you how much government aid you qualify for. Government tuition aid is delivered to students in the form of grants, loans, and federal work study opportunities.
If possible, you should also apply for scholarships, apply for other grants, and line up any part-time job opportunities before taking out a student loan. These options offer cost-savings for your education. In contrast, student loans have to be repaid and will require paying not only what you borrow, but also paying interest on the amount.
How do student loans work?
Student loans consist of money that you borrow from either the government or a private institution to fund your education. Since this is money that you BORROW, you will have to (eventually) pay it all back, plus interest. We’ll get to that in a minute.
Students who are enrolled at least part-time are not usually required to make payments on their student loans while they are in school. After graduating from college, students will have a grace period of roughly 6 to 9 months before they are required to begin making student loan payments. This is meant to give students time to find a job and be earning a fair income before they have to worry about student loan payments. In contrast, if you choose to go on and complete a Master’s degree or a Ph.D. program, you can hold off on making student loan payments until you are no longer in school. As long as you are enrolled in some kind of higher education program, you are not usually required to make student loan payments.
However, you will have to repay what you borrowed eventually. More than that, not only will you be required to repay what you borrowed, but you’ll also be paying INTEREST.
How does interest work?
Interest is basically a fee that you pay the person or entity that you borrow money from ON TOP of the total cost of the loan you took out. When you borrow a chunk of money, the loan has an interest rate associated with it. For mortgage loans when you buy a house, this is generally about 5%. For credit cards, this is usually much higher at roughly 20%. For student loans, this can range from 2% to 12%+.
For example, lets say I borrow $10,000 from a bank so that I can buy a car. The car payment is $250 each month, and the annual interest rate is 6%. That means that each YEAR there will be an interest rate of the total of 6%. 6% of $10,000 is $540. This is the extra amount I will pay to the bank to make it beneficial for them to loan me money. However, they won’t ask for this interest payment in one lump sum — instead, they’ll apply some of the amount to each of my monthly statements for the year. If I divide the $540 by my 12 monthly payments, I’m paying approximately $45 each month in interest. This is a line item you will see detailed in your monthly student loan statements that is already calculated into your monthly payment amount.
Student loan interest rates can be huge - 12% or more! That’s why it’s important to know the facts and figures of your specific loans, so you know what to expect when you see those pesky interest charges on your monthly statements. We encourage you to actually read and understand your statements so that you know how your money is being dispersed between principal and interest. Early into your student loan repayment, you’ll be paying much more toward interest than toward principal.
Alas, there’s no way to get away from interest rates. Why else would the banks lend you money? They make a profit by charging you interest. But the total profit they make depends on a couple of things: how high the interest rate is, and WHEN the interest begins accruing. Some student loans don’t begin to accrue interest until you’ve graduated, while others accrue interest the ENTIRE time you’re in school.
It’s important to know what types of student loans you sign up for, what their interest rates are, and when you’ll need to repay them. Keep reading to learn more about the different types of interest rates you could see for different student loans.
Two categories of student loans: FEDERAL and PRIVATE.
Federal student loans are money you borrow from the government. In contrast, private student loans consist of money that you borrow from private institutions. There are some key differences between these two types of student loans, including repayment options and typical interest rates. Here, we’ll break down what you need to know about the types of student loans so that you know exactly what you’re signing up for when you agree to certain types of student loans.
FEDERAL STUDENT LOANS VS PRIVATE STUDENT LOANS
Federal student loans are generally more appealing than private student loans for a handful of reasons. Here are some key characteristics of typical federal student loans and how they differ from private student loans.
Lower interest rates - Since this money is coming from the government and not from a private institution, the interest rates are generally much more reasonable than those of private student loans. Federal student loan interest rates tend to range from 2% to 6% annually. Private student loan interest rates can be incredibly high, easily reaching 9-12% or higher.
Fixed interest rates - Federal student loan interest rates do not change during the life of the loan. That’s why they’re called FIXED interest rates. In contrast, private student loans can have either fixed or variable interest rates. If you end up with a private student loan that has a variable interest rate, that rate could change from time to time as the economy changes. It is not uncommon for a student loan with an interest rate of 6.0% to jump quickly up to 7.6% without you knowing.
Cosigners are not usually required - A cosigner is someone that applies for a loan with you to give you a better chance of being approved for a higher amount of money or a lower interest rate. This person is generally someone that has a long credit history and a good credit score. If a student includes a cosigner on a student loan, that person would become responsible for repaying the loan if the student were unable or unwilling to do so. This is an additional safety net that the lender takes to make sure they’ll get their money back. Since a cosigner is not usually required for federal student loans, the student can take out these loans in their own name and does not need their parent or guardian to be included on the loan. Private student loans will require either a cosigner or a credit check before entering into a loan.
Credit checks are not usually required - Credit checks give an institution access to a borrower’s credit score as a way to gauge their likeliness to repay a loan. A credit score is calculated based on prior lines of credit and a borrower’s track record of making payments on time. Since federal student loans tend to lack this requirement, it makes it easier for a student to obtain a federal loan, as most students will not have a substantial credit score (or any credit score) by the time they apply for student loans. As mentioned in the last point, private loans will either require a student to have a substantial credit history and healthy credit score, or they will have to include a parent or guardian or other adult on their student loan application.
Postponement options - If you’re having trouble making your monthly payments for your federal student loans, its possible that you could qualify for a federal student loan postponement program or a lowered monthly payment. There are resources available through the Federal Student Aid website if you need this type of support. Sadly, this type of support does not usually exist with private student loans. Private institutions will charge high late fees for late payments and remember that your interest will continue to accrue at its unkind rate as well.
Flexible repayment options - Federal loans will also be more lenient with how you pay them back and when you pay them back. There are different repayment options that students can pick from depending on their situation. For example, the graduated repayment option allow students to begin their repayment with smaller monthly payments that gradually get larger as time goes by. This is based on the idea that most students will make less money right after graduation than they will down the road when they have some work experience under their belts. You can read about this and other repayment possibilities on the Federal Student Aid site. Similarly, you can pick how long you want to spend repaying your student loans. You can choose a 5-year term (this is not very common for a new college grad) with much higher monthly payments or a 15- or 20-year term with much lower monthly payments. Private institutions will usually let you determine your repayment period as well, but make sure to check your specific agreement to know for sure. There’s a lot that gets hidden in those teeny tiny Terms and Conditions.
Possible loan forgiveness programs - If you go into some particular professions, you could be eligible for full or partial federal student loan forgiveness someday. This is true for certain teaching professions and public service professions. These tend to be lower-income professions and you are required to hold a position for a certain number of years before you are eligible for potential loan forgiveness, but it’s good to know about this possibility. If this is something you’re interested in learning more about, go check out the loan forgiveness resources on the Federal Student Aid website.
Consolidating loans - Many students will need to take out student loans for each year of schooling that they complete. Each of those will likely be a separate loan, and usually there is actually a separate federal loan for each semester you need a loan. That means you could have 8 or more federal student loans by the time that you graduate with your undergraduate degree. You have the option of consolidating these loans — this just means sticking them all together into one loan with one interest rate and one monthly payment. This could be beneficial if the overall interest rate of the consolidated loan is lower than most of your individual loans, or if the monthly payment ends up being lower than paying all 8 separately. If you have multiple private student loans, you may have the option of consolidating these as well. You can always shop around and get rates from other lenders to refinance any of your student loans. This tends to be more beneficial for private loans than federal since the federal interest rates are pretty generous. Refinancing means that a different institution pays your current lending institution in full for your current student loans, paying them off for you. In exchange, the new institution turns around and offers you a new loan for the total amount of the refinanced loans and a different — usually lower — interest rate.
No prepayment penalty - There is no penalty if you choose to pay off your federal loans early. In contrast, some private loans include a prepayment penalty fee. If this is true of your private student loans, it will be included somewhere in your Terms and Conditions.
These qualities cover all federal loans, and the federal loan program offers many different individual types of student loans. You may be eligible for some of the following:
Types of Federal Student Loans
Subsidized: When you apply for financial aid, the government determines what kind of aid and how much aid you qualify for. Subsidized loans offer students money to use for their education, but they are not required to pay interest while they are still in school. The loans will accrue interest while the student completes their schooling, but the government will pay for this interest until the student’s grace period ends after graduation. That means the amount that you owe will remain stagnant until your grace period ends six months after you graduate. Then the interest starts to kick in, but not before!
Unsubsidized: Unsubsidized loans DO accrue interest while you are enrolled in school and you are responsible for this money, but these loans tend to have a lower, fixed interest rate.
PLUS loans: PLUS loans are usually either referred to as “Grad PLUS” loans when borrowed by a student directly, or “Parent PLUS” loans when borrowed by the parents of a dependent that is a college student. These are federal, unsubsidized loans, so they will accrue interest while the student is in school. In contrast to the direct subsidized and unsubsidized loans, PLUS loans require the borrow to have a strong credit history and tend to have a slightly higher interest rate, usually sitting at about 7%.
The main thing to know about student loans is that you’re going to have to pay them back and there’s going to be interest involved. The more money that you borrow for your education, the more money you’ll have to pay back in interest.
Are student loans my only option?
The answer to this question is NO. There are other possible ways that you can bring your education cost down or that could help you come up with the money to pay your tuition. Here are some things to consider:
Potential Ways to Make college cost less:
Scholarships and grants through the college - Once you know what schools you plan to apply to, do some research on their tuition and scholarship packages. Visit the Financial Aid and Tuition pages of the colleges’ websites. Many schools will offer automatic scholarships for certain students who meet a specific test score and GPA threshold, and there are many other grants and scholarships that will vary from school to school. Make sure you know what is available at the schools you’ll apply to, and if there is a scholarship that you qualify for, make sure that you know the steps you need to take to be considered for it. Many scholarships will require a separate application from your standard college app.
Outside scholarships - There are TONS of scholarships that people and companies offer to students going off to pursue their undergraduate degrees. Do some research to see if you can find scholarships that you qualify for. It’s possible that your local community and community businesses will have information on local scholarships that you could qualify for. Furthermore, expand your research to outside your community. If you’re involved in a specific group or have a history of working for a particular cause, it’s possible that you could find many scholarships that fit with your background. Once you find scholarships that you qualify for, most scholarship applications simply include filling out a form and writing an essay. Take your time and make sure you submit a strong application. Every penny that you can save on your college education will pay off in the long term because that is money that you won’t have to pay anyone back, and it will therefore not be subject to interest.
Ask Mom & Dad (or a close relative, family friend, etc.) to help out: This one can get kind of awkward, but it could still totally be worth doing. If you know Mom and Dad aren’t planning to help you pay for college, you could still try to get some kind of assistance from them. A couple of my college friends actually took out loans from their parents to pay for their tuition. The difference between borrowing money from your parents and a bank? There’s no interest! (Unless your parents are kind of cruel.) Additionally, your parents are probably going to be more lenient about when and how you pay that money back than a bank will be. I’m not saying that your parents are going to for sure offer to help you out in this way, but it might be worth asking. It could save you thousands of dollars in interest.
Get a job: This shouldn’t come as a surprise. How do most people make money? They have a job that pays them to do a certain task. You pay for college one semester at a time. Even if you may not be able to cover your entire college tuition costs by working a part-time job, you could definitely make a dent in it. Even if you still take out student loans for the full amount of your tuition, remember that you CAN make payments on your loans while you’re still in school. This is actually INCREDIBLY beneficial because it will lower the total amount of interest you’ll pay in the long-run. Anything that you can throw at your college costs while you’re still in school will be well worth it.
College is expensive to the point where many students will still rely somewhat on student loans to help them to get through school. However, the less money you have to borrow for your education, the less money you have to repay and the less interest you’ll end up paying in the long haul. Consider at least combining some of these other potential cost-saving opportunities above with your student loans to save yourself from paying so much in tuition now and interest in the future.
No matter what you decide, the key takeaway from this post should be that you should make sure you’re informed about the financial aspect of your college education and know your plan for paying for it.