If you're thinking about college, you're probably also wondering: How do student loans work?
Learners looking for help paying for their education usually end up researching student loans. While these loans can provide invaluable aid, they are also a significant financial responsibility that should be considered carefully. Loans can affect your life for decades after graduation, which is why it's best to do your research before diving into this responsibility.
This primer explores what to expect from student loans, including costs, benefits, and terms, along with helpful advice on how to apply for a student loan.
What Is a Student Loan?
In addition to scholarships, grants, and work-study programs, many learners turn to student loans to fund their education. Student loans provide learners nationwide with financial assistance: Student Loan Hero reports that 69% of students in the class of 2019 took out loans to pay for their schooling. Student loans can be a useful tool, provided you use them responsibly.
Student Loan Hero's data also shows that students in 2019 graduated with an average debt of $29,000. The ease with which you can access large amounts of money through student loans can be deceptive; it's best to try to borrow as little as possible to minimize the long-term costs. It's best to research starting salaries in your field to determine your ability to pay back loans after graduation before committing to a large loan.
Types of Student Loans
There are two primary student loan types: private student loans and federal student loans. Both can potentially help reduce financial anxieties and build your credit score, but they offer distinct drawbacks.
Federal Student Loans
Student loans from the federal government offer many advantages, such as fixed interest rates. Federal student loans also offer more flexible repayment plans and access to loan forgiveness programs, under certain conditions.
Typically, the amount you can borrow each year depends on your education level and status as a dependent or independent student. Yearly loan limits can vary from $5,500-$12,500 for undergraduates. Loan limits for graduate students can reach up to $20,000.
Direct Subsidized Loans
Direct subsidized loans provide financial aid to undergraduate students who demonstrate outstanding financial need. The loan amount may not exceed the student's need, but the borrower does not need to pay any of the accrued interest during their schooling or for the first six months after graduation.
Direct Unsubsidized Loans
Direct unsubsidized loans are offered to all undergraduate and graduate students, whether or not they demonstrate financial need. Your school determines the amount of the loan you receive based on other financial aid you have accessed. Unlike subsidized loans, unsubsidized loans require students to pay interest as soon as they begin repaying the loan.
Direct PLUS Loans
Direct PLUS loans allow graduate and professional degree students and the parents of dependent undergraduate students to access federal financial aid. These loans require the borrower to pay interest during all periods. If you take out a direct PLUS loan, you will also need to pay an origination fee deducted from the loan disbursement.
Direct Consolidation Loans
Direct consolidation loans allow you to combine multiple federal loans into a single federal loan. These loans offer lower monthly payments and more diversity in repayment plans, which decreases the likelihood that the borrower defaults. They also enable you to apply for certain loan forgiveness programs. To find out more about how to consolidate student loans, contact your loan administrator.
Private Student Loans
You should only resort to private loans when you have maxed out federal financial aid, due to their disadvantages. Private loans usually come from banks or other private companies and may end up costing you more in the long run. You might also need to start making repayments on them while still in school.
Before committing, consider the costs associated with private student loans. You will need to pay a lender fee to the vendor, who may not allow you much freedom in choosing a loan repayment plan. The terms for repayment vary by vendor.
Private loans are often unsubsidized and may come with an annual cap that limits the amount of aid you receive. Interest rates for private loans are also variable. Your credit history and that of your cosigner can affect all of these factors, especially the interest rate.
How Are Student Loans Paid Back?
Degree-seekers have many options when it comes to federal and private student loan repayment programs. Here are a few common formats that repayment can take.
- Income-Based Repayment: The borrower pays 15% of their income monthly for up to 25 years.
- Standard Repayment Plans: You pay a fixed amount monthly for up to 10 years. Payment rate varies based on the loan amount and interest rate.
- Graduated Repayment Plans: Over 10 years, a student makes low, monthly payments that gradually increase every two years.
- Extended Repayment Plans: The borrower makes very low monthly payments over the course of 25 years.
- Revised Pay-as-You-Earn Repayment Plans: You pay 10% of your income each month over 20-25 years.
- Income-Contingent Repayment Plans: Students make very low monthly payments adjusted to low-income work for over 25 years.
Federal student loans typically allow a six-month grace period before you need to make payments. Once the grace period ends, you must begin making payments monthly and on time. Interest is added to your payment each month, usually at a fixed rate.
If you take out multiple federal loans, you may want to consider consolidating your loans through a direct loan consolidation program. These programs combine federal loans from different lenders into a single loan you can repay using a standard, extended, or income-based plan.
It typically takes 10 years to repay a federal student loan, while private student loans usually take 5-15 years to repay.
Students also have options for pursuing student loan forgiveness, as listed below.
- Public Service and Teacher Loan Forgiveness: This option forgives remaining loans for public service workers and teachers working in high-need areas.
- Closed School Discharge: Students whose schools close before they can earn a degree often receive loan forgiveness.
- Total and Permanent Disability Discharge: This option forgives all loans for students who have permanent disabilities.
- Death or Bankruptcy: These two cases result in forgiveness of most loans, though you must apply for student loan forgiveness due to bankruptcy separately.
Follow this link for other types of loan forgiveness not listed above.
What Happens if I Miss a Payment?
Loan default causes damage to your credit score and allows the federal government to use your tax refunds to offset your debt. Given these risks, you should choose repayment plans carefully to ensure you pick one that you know you can manage.
If you miss a payment, you can mitigate the damage in several ways. First, applying for loan forbearance or deferment allows you to suspend payments for a short period. Unfortunately, interest may still accrue during this period, halting progress toward loan repayment or forgiveness. Deferment/forbearance also gives you time to change your repayment plan to an income-driven pathway that aligns better with your earnings.
Federal loans allow nine months of missed payments before you must default on a loan, but private loans may only allow one missed payment. You can potentially escape loan default by applying for loan rehabilitation or loan consolidation, both of which allow you to negotiate with your lender for lower monthly payments.
How to Get a Student Loan
The process for how to take out a student loan can vary, depending on what kind of loan it is and how much financial support you need. The following set of steps describes the most common process for pursuing financial aid, whether for a traditional or online program:
Complete Your Free Application for Federal Student Aid
Completing the FAFSA to determine your eligibility for federal financial aid is the first and most important step. Repeat this step every year for as long as you wish to receive federal aid.
Apply for Grants and Private Scholarships
Grants from the federal government and scholarships from private organizations can take a chunk out of your schooling expenses.
Communicate With Your School
Your school's financial aid office will work with you to apply any federal aid you receive to your account.
Complete Prep Work for Your Federal Loans
If you receive federal student loan money, you may need to complete entrance counseling to understand your responsibilities as a borrower. You will then need to sign a master promissory note for each loan you took out.
Apply for Private Student Loans
Once you've maxxed out all other forms of aid, consider a private student loan from a reputable lender such as College Ave, SoFi, or Earnest to make up the difference. Be sure to check terms and conditions thoroughly before committing to a loan.
Frequently Asked Questions
How Long Can You Get Federal Financial Aid?
There is no time limit on federal direct unsubsidized loans or PLUS loans. For all other federal loans, you can only receive aid for 150% of the published length of the program you intend to complete. For example, you can only receive federal aid for a four-year bachelor's degree for six years.
How Do You Qualify for Federal Loans?
To qualify for federal loans, you must first present citizen or eligible noncitizen status, along with a valid social security card, selective service registration, and a high school diploma or equivalent with a 2.0 minimum GPA. Then you must fill out the FAFSA form and enroll in an eligible school on at least a part-time basis.
Is There an Income Limit for Federal Student Loans?
There is no income cutoff for federal student aid. However, you should note that your income will influence the amount of student aid you can receive. Completing your FAFSA allows federal aid to calculate your estimated need based on the cost of attendance at your school minus your expected family contribution.
How Do You Get Approved for a Private Student Loan?
Private student loans set their own loan approval requirements, which typically include age, education, and citizenship requirements; enrollment in an eligible school; and an adequate credit score and income. Private lenders may also require a cosigner on your loan. The lender will likely send funds directly to your school.
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