Don’t spend the next 20 years repaying your college loans. Here is everything you need to know to pay off that student loan debt.
With more than 7 in 10 students leaving college today with student loan debt, it’s safe to say that a college education would not be possible for most students without it. A big reason for the increase in student borrowing is the increased availability of loans to a broader spectrum of students in need. In addition to the expanded access to federal student loans, students also have access to private student loans through a growing network of private lenders.
While both types of loans serve the same purpose, they are vastly different in a number of ways. Before looking into college financing, it would be very important to understand all of your federal and private student loan options and their differences in light of your particular financial situation and needs.
Understanding Federal Student Loans
For undergraduate students there are essentially two types of loans – subsidized and unsubsidized. Subsidized loans utilize federal dollars to pay the interest while you are in school and for a predetermined time following graduation. The Perkins Loan is subsidized for the most financially needy students while the Stafford loan will subsidize a broader range of financial need.
For students from families that are able to make a financial contribution, there are two alternatives: An unsubsidized Stafford Loan and a PLUS Loan. The Stafford Loan is issued to students and requires full payment of interest during attendance at college. The PLUS Loan is issued to the parents of students and generally requires that applicants have a good credit standing.
Student Loan Repayment
Equally important to determining the type of student loan to take, is determining the repayment plan that best suits your financial situation. Most student loans are issued under the assumption that you will, at some point be earning a living with the capacity to start repaying them. That may not always be the case, and some students find themselves in difficult financial situations with no income to make the payments. Most of federal student loans have various repayment options.
With federal loans, students may elect to defer payments until six months after they leave school. However, interest begins accruing to the loan from the beginning. It is strongly recommended that borrowers at least make interest payments on their loans to prevent payment shock when payments start. In today’s tough economy, many graduates are having a difficult time finding gainful employment that can generate sufficient cash flow; so, there are a few additional repayment options available to ease the burden.
Income-driven repayment plans: Student borrowers facing a hardship can convert their federal loans into an income-driven repayment plan. With these plans you can extend the repayment term which can lower your monthly payment. Your payment is also capped so it doesn’t exceed a certain percent of your take home pay. Because your financial situation can change from year-to-year, these plans require that you reapply each year.
Deferment: For students who can demonstrate an inability to make payments at all some federal loans allow for a deferment of principal and interest payments, while others only allow for principal deferment. It would be important to try to keep up with your interest payments as these can accrue and compound into a much bigger problem down the road.
Forbearance: A loan forbearance can be requested if you can demonstrate financial hardship which prevents you from making loan payments. Typically the loan terms are revised to where the balance is reduced or the payment schedule is postponed. In most cases, you will still be required to make the interest payments.
Congress sets the interest rates on all new federal loans except Perkins loans each year. For existing loans, the interest rate is fixed for the loan term.
Understanding Private Student Loans
Private student loans, issued by private lenders, such as banks, are most often used to help students cover the costs of college that are not covered by their federal student loans. They are also a source of funding for students who borrow the maximum amount of federal loans and still need money. Students using private student loans can finance up to 100% of their college costs, including books, housing and tuition.
As explained by LendEDU, to obtain a private student loan borrowers must be able to qualify based on their credit. Federal loans don’t require credit qualification; only a demonstrated need. For that reason, about 90% of all private student loans are cosigned by a parent or other creditworthy person.
Private Loan Repayment
As with federal student loans, many private lenders allow for a six month grace period before repayment must begin. Once payments begin, borrowers have limited options available to them should they run into financial trouble as there are no income-driven repayment plans. However, some lenders are adding a deferment and forbearance option for extreme hardships. Private lenders do offer a refinancing option for both federal and private loans, which has the potential to lower interest costs.
Depending on the creditworthiness of the borrower or a cosigner, the interest rates on private student loans can be lower than on federal loans.
Why Use One or the Other?
The general consensus is that you should first look to federal student loans for your college financing. They are easier to obtain and they offer much more flexibility in their repayment options. Income-driven plans can not only provide immediate budget relief, they also make you eligible for loan forgiveness down the road.
Private loans should be considered when you have no other financing options available and you still have college costs to cover. Although private loans do offer the potential for lower interest rates, they are largely devoid of many of the protections that millions of student borrowers rely on when times get tough.