- If you’re an undergraduate student, you should always apply for federal student loans first.
- If you need to consider private student loans, it’s important to prepare your creditworthiness as a borrower prior to applying in order to get the best rates.
- Student loans are an important vehicle to education and self-development, but they carry costs you should be aware of.
You finally made it. You graduated from high school, and you’re about to embark on your journey to higher education. But before you begin, you need to figure out exactly how you’re going to finance your degree.
It’s best to explore all potential sources of income before taking out a loan — after all, you don’t want to take on debt unless you need to. Income sources include scholarships, grants, work-study programs, and options like taking a gap year to save money while working or looking into a reimbursement benefit from your employer. We can’t stress enough the importance of considering all possible funding options before taking on student debt.
If you determine that you need to take out student loans, know that you’re not alone. After all, student loan debt in the U.S. recently reached $1.6 trillion. With this much impact on your finances, it’s wise to do your research. Below, we’ll break down some of the most important things you should know about how to get a student loan.
How to Get a Student Loan: Your Options
When it comes to financing higher education, there are two primary loan types: federal student loans (unsubsidized and subsidized, which we’ll cover below) and private loans. You should first consider subsidized federal student loans. Since the government covers interest costs while you’re in school, these loans don’t require any interest payments until you’re done with college. Your loan balance and therefore monthly payments will likely be lower than they would be with unsubsidized federal loans or private loans, your interest rates could be lower, and the credit requirements aren’t as stringent.
However, that doesn’t mean private student loans are out of the question. After all, some people might need to consider private student loans in the event that they can’t get enough funding through federal student loans. Below, we’ll explore the two primary loan types in more detail.
Federal Student Loans
The first step you’ll want to take when looking into student loan options is filling out the Free Application for Federal Student Aid (FAFSA). This form from the federal government considers the cost of attendance for college minus the expected contribution from your family (i.e. your financial need). The FAFSA relies on information from your tax return from two years before you submit the application. For example, if you’re beginning school in Fall 2020, you would apply for FAFSA in 2019 using the tax return you submitted for the 2018 tax year.
When it comes to the FAFSA loan application, although both you and your parents’ financial information is taken into account, your income and assets as the student matter more than your parents’ income and assets. Income also has a higher impact on your eligibility for aid than assets.
Because of the two-year gap between when the taxes are reviewed and when financial aid is actually given, it’s important to plan your finances in advance. To increase the chances of receiving financial aid, you and your parents should plan two tax years ahead of aid disbursement by reducing your gross income, if possible. Maximizing retirement and health savings account contributions are a few deductions to income you can take.
Keep in mind that there are deadlines for filling out the FAFSA each year, and you must apply for aid each year. If you’re curious about how much federal financial aid you might be able to secure, you can get an estimate using this tool.
The Difference Between Subsidized and Unsubsidized Loans
When it comes to federal financial aid loan programs, there are both subsidized and unsubsidized loans. A direct subsidized loan, which comes from the U.S. Department of Education (DOE), is determined based on your financial need.
Direct subsidized loans are much better than direct unsubsidized loans. This is because you’re not required to pay any interest on the loan during the duration of your education, and there is a grace period following graduation (typically six months) during which your loan does not incur interest. Direct subsidized loans are only available to undergraduate students.
Direct unsubsidized loans, on the other hand, are also issued by the DOE, but, unlike subsidized loans, they accrue interest while you’re in school. This means the financial burden of these loans is much greater. The benefit for many is that a direct unsubsidized loan doesn’t require a demonstration of financial need.
Both subsidized and unsubsidized federal student loans have the added benefit of student loan deferment or forbearance, repayment flexibility (such as income-based repayment plans) and even loan forgiveness, making these loans the best option for many students to consider.
Private Student Loans
As we mentioned above, you should only consider loans from private lenders once you’ve already taken a look at your other options, such as scholarships, grants, work-study programs, and federal loans. If you still need access to a loan for higher education purposes after exhausting these options, you can consider a private student loan.
You’ll want to focus on finding a loan that comes from a reputable lender and matches your needs for borrowing, preferred terms, and repayment schedule.
The most important thing to keep in mind when it comes to private student loans is that your loan begins to accrue interest immediately and that repayment terms are a lot less flexible than federal student loans.
In order to secure the best interest rates possible on private student loans, you’ll need a good credit score, so you should prepare your credit ahead of time. If your credit score isn’t good (meaning in the high 600s or low 700s), you might be required to have a parent co-sign your loan. To get started, check out this article on how to build your credit history without a credit card.
The Hidden Cost of Compound Interest
You might have heard of compound interest before, but you may not know exactly what it means. In the event that you’re taking out a private or unsubsidized student loan, you should be aware of compound interest, as it can create a significant financial burden.
Let’s say you’re taking out a $10,000 student loan. You pay interest on that loan balance, and the interest charges are calculated daily. If the interest rate on your student loan is 6%, you don’t just pay $600 each year to borrow that money. Instead, the 6% is calculated based on a daily rate.
Here’s an example of this in action: When 6% is divided by 365, you get 0.0164%. On the first day you possess the loan, this amount is charged on your $10,000 loan, leaving you with a repayment balance of $10,001.64. On Day 2, the daily rate is charged based on the new balance — $10,001.64 — and so on and so forth. This, of course, adds up to much more than $600 annually.
When you take out a federal subsidized loan, the government pays your interest while you’re a student, meaning upon graduation (plus a six-month grace period), you owe just the loan amount to repay. Unsubsidized and private loans, on the other hand, gain interest while you’re a student, which can be much more costly in the long run.
What to Know as a Parent
If you’re a parent interested in helping your child pay for his or her education, it’s important to know that there are certain parent loans for undergraduate students that have competitive rates, such as Direct Plus Loans. In this case, the parent receives the loan to help pay for the child’s tuition, fees, room and board. Note that with the parent PLUS loan, only you as the parent are legally responsible for the loan and the obligation cannot be transferred to your child.
As a parent, you can also co-sign for private loans if your child’s credit isn’t sufficient to qualify. However, before becoming a co-signer on a private student loan for your child, proceed with caution. You should only become a co-signer as a last resort and once you’ve evaluated your child’s ability to repay the loan following graduation.
Student loan debt has grown quickly in the Baby Boomer population, according to the Associated Press. In fact, in the past five years, the 60- to 69-year-old age group has seen a 72 percent increase in their student loan balances. Unfortunately, many of these Baby Boomers are funding these loans using their own retirement savings or Social Security benefits.
It’s important to fund your personal savings (e.g. emergency fund, retirement savings, and even your own professional development) before signing up to be on the hook for your child’s student loan debt. After all, as the old saying goes, “Put on your own oxygen mask first before assisting others.”
Get a Student Loan the Smart Way
The best way to ensure you’re being smart when it comes to student loans is by planning ahead to maximize your opportunities for funding while minimizing your needs for debt.
Before considering student loans, look for ways to lower the cost of attendance and, in turn, the need for debt. Are there scholarships or grants you qualify for? Is one college a better financial option than another? Are there ways for you to earn income while you’re in school? Could the local community college be a cost-efficient way to complete the first two years?
If you know you’ll need loans, prepare your finances for the FAFSA, and work to improve your credit score in the event that you’ll need to take out private loans. As you prepare yourself financially for college, you’ll be learning important financial lessons that will help you later in life. Consider it a lifelong education that will reward you along with your degree.