- Before starting college, it’s important to figure out the cost of attendance minus the resources you have available. Then, you can fill in the gap with student loans.
- There are three primary types of student loans: federal subsidized loans, federal unsubsidized loans, and private loans.
- Look at ways you can lower the cost of attendance through scholarships, grants, and other educational options, in addition to researching borrowing options.
Long gone are the days when college tuition was a mere $5,000 or $10,000 per year, easily funded by taking on a part-time job in the cafeteria or athletic facility. The average cost of attendance for a higher education four-year degree program in the U.S. is $41,000 per year for private universities and nearly $20,000 per year for public universities, according to data from the National Center for Education Statistics. In the year 2000, these numbers were a little over $21,000 and $8,000 respectively, meaning costs have doubled in less than 20 years.
Because of the rising cost of attendance for college, many students are relying on student loans. In fact, over 44 million adults in the U.S. (roughly one in five people) have some form of student loan debt, with the country’s total student loan debt topping $1.6 trillion.
Before taking on student loan debt, it’s important to know what you’re getting yourself into so you can be as educated and discerning as possible about your obligations over the life of the loan. After all, selecting the best loan possible will reduce your financial burden come graduation. Below, we’ve explored everything you need to know about how student loans work.
How Do Student Loans Work?
Student loans work much like other types of loans: You find a lender, take out a loan, and repay that loan over the course of a set term with a set interest rate. The primary difference between student loans and other loans, such as mortgages and auto loans, is that the federal government offers student loan options. Read on for more detail on the different types of student loans.
There are two primary types of federal student loans: subsidized loans and unsubsidized loans.
Subsidized loans come with better terms (e.g. lower interest rates and better loan repayment options) than unsubsidized loans and private loans. Sometimes referred to as Stafford Loans, subsidized loans help students who demonstrate the most financial need.
Federal subsidized loans are only available to undergraduate students. The best part about them is that the U.S. government pays your interest while you’re still a student (so long as you’re attending at least half-time), meaning you won’t have to make any loan payments until you graduate. Plus, subsidized loans come with the option of a six-month grace period following graduation, meaning you have some wiggle room to get your first post-college job set before payments are due.
To apply for subsidized loans, the first step is filling out the Free Application for Federal Student Aid (FAFSA). Although both you and your parents’ financial information is taken into account, your income and assets matter more than your parents’ for the FAFSA. In addition, income has a greater impact on your eligibility for aid than assets do.
Keep in mind that there is a two-year gap between when your taxes are reviewed and when your financial aid is actually given. For example, if you’re applying for federal financial aid for the 2019-2020 school year, your 2017-2018 taxes will be reviewed. Because of this, it’s important to plan your finances in advance. To increase your chances of receiving financial aid in the form of subsidized loans, you and your parents should start planning two years ahead of aid disbursement. If possible, reduce your gross income by taking allowable deductions where you can, such as maximizing your deductible retirement and health savings contributions.
There are deadlines for filling out the FAFSA each year, which vary depending on the state you live in. If you’re curious about how much federal financial aid you might qualify for, you can use this tool to get an estimate.
Federal unsubsidized loans are available to both undergraduate and graduate students. Their interest rates are slightly higher than those of subsidized loans (6.08% compared to 4.53%, as of July 1, 2019), and you don’t get the benefit of deferred interest with unsubsidized loans — you have to make payments throughout the course of the loan, including while you’re a student.
For both subsidized and unsubsidized loans, the loan amount you receive is based on the cost of attendance, plus any other financial aid and support you have access to, including your salary or wages and family resources.
If you cannot demonstrate enough financial need for subsidized loans, you need more than the subsidized loan limit, or you’re a graduate student, you’ll likely want to consider federal unsubsidized loans. As with subsidized loans, you’ll want to fill out the FAFSA in order to get started.
Direct PLUS Loans
A third loan type available from the federal government is Direct PLUS loans. They are available to parents of students, as well as graduate and professional students. Keep in mind that in order to qualify for Direct loans, you must have good credit, as a credit check will be done. If you have a low credit score or credit history that includes adverse events like bankruptcy, you might not qualify for a Direct PLUS loan.
Typically speaking, you should attempt to secure subsidized loans and unsubsidized loans before you begin looking into private student loans. This is because there is no deferment period with private loans, some loans come with variable interest rates as opposed to fixed rates, and the loan terms tend to be more stringent. Plus, there are some credit requirements for private student loans.
If you’ve already explored federal loan options, as well as other funding paths (like grants, scholarships, and work-study programs), and you still need financial assistance, you can consider private loans from banks, credit unions, and other financial institutions. Make sure you compare interest rates and loan terms (such as the repayment schedule) across several lenders in order to secure the best option.
A word to the wise: Although federal loans tend to have better terms, it’s possible to secure better interest rates on private student loans, so long as you have a great credit score. If you think you’ll be taking out private student loans to finance your education, it’s wise to prepare your finances ahead of time in order to have an optimal credit score. Depending on your financial situation, you might also need a cosigner, like a parent, if you opt for a private student loan.
How Do Student Loans Get Repaid?
As we explored in some detail above, the different types of student loans all get repaid differently. Below, you’ll find a breakdown of how repayment works for each loan type:
|Subsidized Loans||Unsubsidized Loans||Private Student Loans|
A key advantage of federal loans is that they generally have options for student loan deferment if you encounter temporary difficulties in repaying your loan. These deferment options are more flexible than what private loans offer. Federal loans can also be discharged (automatically forgiven) in the case of death or permanent disability, whereas private loans may not be easily forgiven and could be passed on to your survivors or estate.
A Note on Compound Interest
Because interest begins accruing immediately with unsubsidized and private loans, it’s important to be on top of your monthly payments because of compound interest.
With compound interest, interest accrues on top of interest, meaning your balance could grow exponentially if you miss making interest payments while you’re still in school. For more information, this guide on how to calculate interest rates contains a breakdown of how compound interest works.
The Importance of Planning
The best way to ensure your student loan experience goes as smoothly as possible is by planning ahead, including planning on minimizing the amount you borrow. There are countless ways you can reduce your cost of attendance, such as applying for scholarships and grants, working part-time, and considering community college first, then transferring to a four-year university later. Explore these options in depth before taking out potentially costly student loans.
It’s also important to carefully choose the school you attend. Weigh the quality of the education against the college costs and your earning potential following graduation to figure out which school is the most cost-effective and career-enhancing choice for you.
The smartest move you can make is doing your homework now so that you can select the best student loans possible. You’ll be debt-free and thriving financially before you know it.