Your Student Loan Guide: What You Need to Know
Loans can seem like a great way to help you achieve your dreams of higher education. After all, if someone is giving you money to go to school, who wouldn’t say — sign me up!
However, student loans – while helpful – are not a ‘gift’, they do need to be paid back. In addition, they can never be removed from your credit history or the debt forgiven, except for rare and specific situations, which the average student is unlikely to qualify for.
Fortunately there are a lot of options to help you get the financing you need to pay for your education, and to get help paying off your loans in a timely manner. However, it's important you understand what you're getting into to avoid graduating and only then realizing how much you have to pay back.
The federal government offers loans in a few different flavors. Loans can either be subsidized or unsubsidized. It’s critical to understand the distinction, and how interest on the loans can add up, in order to avoid unpleasant surprises.
In order to qualify for an federal loan or grant, you have to complete the FAFSA (Free Application for Federal Student Aid).
Subsidized loans have slightly better terms to help out students who have financial need. The greatest benefit is that the interest is paid for by the government while you are enrolled in college and for six months after graduation.
Unsubsidized loans start accruing interest immediately after disbursement – in other words, as soon as the loan is approved and the college receives the money.
If you choose not to pay the interest on an unsubsidized loan while you are in school, it will accumulate and then be added to your principal. This can really add up after four or five years, and result in a much larger amount to pay back than what you originally planned for.
In 2012 there was some debate about how to handle the student loan interest rate. The bipartisan plan that is currently in place is to tie interest rates to the 10-year Treasury note.
Both subsidized and unsubsidized loans disbursed between July 2014-2015 have an interest rate of 4.66%, fixed throughout the lifetime of the loan.
*Update: Loans disbursed between July 2015-2016 have an interest rate of 4.29%.
Every June the interest rate will be modified for new loans, and could be allowed to rise as high as 8.25% and 9.5% for subsidized and unsubsidized loans, and 10.5% for PLUS loans.
How Quickly the Interest on Loans Can Add Up
Let’s say you take out $2,000 of unsubsidized loans in your first year of school. The interest rate on federal unsubsidized loans is 4.29%. You decline to pay the interest while in school. By the time you graduate in five years (most students take more than four years to graduate), how much will you have to pay back? Your loan has grown from $2,000 to $ 2,429.00!
Most students have to take out vastly more than $2,000 in unsubsidized loans, and the interest will grow even more if it takes you longer to graduate. You’ll also have to keep in mind that interest rates for new loans will change, and are likely to go up.
How Much Can you Borrow?
The school you choose to attend will determine your eligibility amount. The federal government has also placed limits on the amount of loans a student can take out; these depend on what year you are in college and whether you are a dependent or an independent student.
- Dependent students whose parents are able to obtain PLUS loans are eligible for $5,500 in their first year, $3,500 of which may be subsidized loans.
- In their second year, these students are eligible for $6,500, of which $4,500 may be subsidized.
- In their third year and beyond, $7,500 a year, $5,500 of which may be subsidized.
- For dependent students, the maximum total debt allowed is $31,000, of which no more than $23,000 may be subsidized. Graduate students are not eligible for subsidized loans.
- The government allows students who are classified as independent to borrow more money, as well as dependent students whose parents do not qualify for PLUS loans. For these students in their first year, they are allowed up to $9,500, with no more than $3,500 being subsidized.
- In their second year, these students are eligible for $10,500, with no more than $4,500 being subsidized.
- In their third year and beyond, independent students are eligible for $12,500 a year, with no more than $5,500 being subsidized.
- The total amount independent undergraduate students are allowed to borrow is $57,000, with no more than $23,000 being subsidized.
- The maximum unsubsidized loan for a graduate degree is $20,500.
- The total graduate debt limit is $138,500 with no more than $65,000 being subsidized. This includes all federal loans for undergraduate study.
There are some exceptions to the loan limitations for unsubsidized loans. These include graduate or professional students enrolled in certain health profession programs. Check with your school to see if you would qualify.
Federal Perkins Loan
The Perkins loan is another federal loan made available to students who demonstrate severe financial need. It's available to undergraduate or graduate students. Interest rates are set to 5% fixed throughout the lifetime of the loan. There is also no loan origination fee, but not every student will be eligible for this loan and not all colleges participate.
The government also offers a federal loan available to parents or graduate students known as a PLUS loan.
PLUS loans are available to parents or independent students and have flexible repayment options. The interest rate for PLUS loans is currently set to 6.84%. Interest begins to accrue immediately and repayments are due as soon as the loan is dispersed. There is also a loan fee of 4.272% of the total amount of the loan.
Do I Need a Cosigner?
For most federal student loans you do not need a cosigner or a credit check.
However you might need a cosigner or endorser in order to take out a Direct PLUS Loan.
Most private loans will require a cosigner. A cosigner with a good credit history can also help you get better rates on private loans.
Borrowing From Private Lenders
Of course, students and their parents always have the options to obtain student loans from private lenders such as banks. Sometimes your financial aid package will even suggest private loans as part of your payment plan.
It's important to note that you do not have to accept any loans included in a financial aid package, federal or private.
In order to get the best rates on a private loan you will typically want to shop around. You should also make sure you have a good understanding of the way the loan works and how much your can expect your payments to be.
Private vs. Federal Loans
Undergraduate students are usually advised to take advantage of federal loans before turning to private loans. This is because federal loans usually have competitive interest rates, flexible repayment options, and other benefits that private lenders cannot match.
However, private lenders may be able to beat rates on government loans for graduate students and parents. Private loans are worth looking at once you've hit your borrowing limit for public loans or have enrolled in grad school.
After graduation, you may be able to save money by refinancing with private lenders.
Make Sure You Understand Total Debt Loads
While sometimes it can seem scary to truly understand debt amounts, especially when you are working towards a diploma and a career, it’s very important to understand how much you are borrowing overall. $6,000 for one year as part of a financial aid package, seems ‘doable’, but at the end of four years that's $24,000 (not including interest).
Keep track how much you are borrowing each year, and how much your expected payments will be.
Use the Repayment Estimator the government provides, and make sure you aren’t over-borrowing to the point where even if you do land a high-paying job after college, you’ll need to live in your parents’ basement because you cannot afford rent, utilities and groceries.