With many colleges costing over $30,000 a year, student loans have become a way of life for most students seeking higher education. Two-thirds of undergraduate students now graduate with student loans, with the average amount over $25,000. While starting off your professional career in debt is not ideal, by understanding student loans and managing your debt, you can remain in control of your personal finances.
Student loan overview
Student loans fall into two main categories. Federal loans, which are guaranteed by the government, and private loans, which are lent by commercial banks and other financial institutions. Student loans are structured specifically to help pay for college, and often offer special interest rates or programs catering to students.
Federal loans are guaranteed by the government and are the most attractive loans for students. Federal loans are typically are offered at lower interest rates then private loans. Additionally, federal loans are structured with special programs designed for students, such as deferments and repayment plans. With the exception of the Perkins Loan, all federal loans are now dispersed directly to students through the Direct Loan Program. Students can qualify for the following federal loans by completing the Free Application for Federal Student Aid (FAFSA):
- Stafford (subsidized): Financial need-based loan awarded and dispersed directly from federal government.
- Stafford (unsubsidized): Not based on financial need, this loan is dispersed directly from the federal government.
- Parent PLUS: Not based on financial need, this loan is dispersed directly from the federal government to the parents of dependent students. This is the only federal loan that uses past credit history.
- Consolidation: Eligible federal student loans can be combined into one loan dispersed directly from the government (see consolidation section below).
- Perkins: Financial need-based loan dispersed by your school. This is not a Direct Loan, rather the school is your lender, and the loan is made with government funds. You must repay this loan to your school.
Federal loans can either be subsidized or unsubsidized. In the case of subsidized loans, the federal government pays the interest on the loan while the student is in school, and during grace or deferment periods. Unsubsidized loans begin generating interest immediately. Students can either choose to pay this interest monthly, or roll the interest into the principle of the loan (called capitalization). Unsubsidized interest can add significantly to the total debt of a student.
Private loans are provided by commercial banks or financial institutions. These loans do not have the special benefits of federal loans and often have much higher borrowing rates then federal loans. These loans should be considered as a last resort when financing your education. Other differences between the major loan categories is outlined in the table below:
|Loan Type||Interest Rate||Max Aggregate Undergrad Borrowing||Subsidized||Grace Period||Term|
|Federal||Stafford (subsidized)||3.4% or 6.8%||$23,000||Yes||6 Months||10 Years|
|Stafford (unsubsidized)||6.8%||$31,000||No||6 Months||10 Years|
|Parent PLUS||7.9%||Cost of school minus other aid||No||6 Months||10 Years|
|Consolidation||Weighted average of loans. Max of 8.25%.||No Limit||No||None||10-30 Years|
|Perkins||5.0%||$27,500||Yes||9 Months||10 Years|
Many students graduate college with several different loans. Loan consolidation combines multiple loans into a single monthly payment. Federal consolidation is offered through the Direct Loan program, and private lenders also aggressively market consolidation loans. The benefits of consolidation include simplifying, and potentially lowering, your monthly payment. However, by consolidating you can lose out on borrower benefits such as deferments or special repayment plans. Additionally, if you lower your monthly payment but extend the term of your loan, you could actually be paying significantly more over the course of the loan due to interest charges. Calculators are available to help you understand the tradeoffs in loan consolidation, and students should carefully consider whether it is sensible to consolidate.
Tips and tricks
There are a few points of caution to keep in mind if you are pursuing student loans. You may be approached by official-sounding organizations offering guaranteed loans or consolidation services, but ensure they are legitimate before responding or providing any information. Advance fee loan scams require upfront payment for loans that never materialize. A good rule of thumb is that you should never have to pay money to get money.
Private loans may be a necessity, but be sure to exhaust all available federal funding first. Filling out the FAFSA early will improve your chances of receiving federal loans. Student loans are not dischargeable in bankruptcy, so you never want to take out more then you will be able to repay. Loan calculators are available to help you understand exactly what you obligation will be after graduation. Knowing your obligation is a huge step towards successfully managing your personal finances.
Additionally, there are other benefits to student loans. Consistent payments on installment loans quickly establishes a track record of good credit. Also, interest paid on student loans is deductible from your federal taxes. Student loans enable millions to earn college degrees, providing job opportunities and $1.2 million in additional income when compared to the earning potential of non-graduates. Armed with the basics presented here, you have taken the first step in financing your education. Leave the stress for finals week.