Contrary to popular belief, student loans aren’t always a bad thing. But I don’t have to tell you how big of a mess the student loan crisis is. So instead of talking about what caused it, let’s focus on your best course of action: figuring our how to understand student loans.
When it comes to student loans, ignorance is stupidity. When I took mine out, I understood them well enough – the problem was that I might’ve borrowed too much. OK – I borrowed too much. I’m happy to say that they’re almost completely paid off, though.
You shouldn’t be scared to take on debt – they can truly be your key to a greater future, assuming you’re prepared and have a solid game plan.
Student Loans 101:
In this guide, I’ll teach you the different types of student loans and their common terms and conditions. When you’re finished, you’ll have a much better sense of how to navigate the process and find what works best for you. Ready to begin understanding your student loans?
The basics: how do loans work?
When you take out a loan, you receive a sum of money from another party on the condition that you’ll pay the sum back over a specified period of time, plus interest. Interest is what you’ll pay for borrowing the money and it’s set by a certain rate, which can be either fixed or variable.
A fixed rate, say 4%, stays at 4% until you’ve paid off the loan. On the other hand, a variable rate of 4% could increase or decrease over time, changing your monthly payments and the total loan repayment amount.
For a typical loan, the borrower is expected to begin making payments immediately. However, since student borrowers have no income, they usually don’t need to begin repayment until they’ve finished their education. Oh yeah – and you’ll need to pay back the loan whether you graduate or not.
A major difference between student loans and other types of loans is the fact that you virtually cannot escape student loans. Declaring bankruptcy is possible on a personal loan, but for both federal and private student loans, you need to take things a step (or three) further.
To get your student loans forgiven, you need to prove that they’re causing you undue hardship, which means:
- You can’t maintain a minimal standard of living for yourself and your dependents based on your current income and expenses
- Your financial situation isn’t likely to change during your loan’s term
- You’ve made good faith efforts to repay the loan
Believe it or not, they don’t evaluate these three aspects lightly. Your best bet is to do a thorough evaluation of your current and future financial situation before taking out any loans. That way, you don’t have to even consider trying to get your loans forgiven.
Here’s a great tool that’ll break everything down for you.
If your loans aren’t forgiven and you’re struggling with payments, you may default on your loan. Going into default means that you’ve failed to pay your loan as agreed, which usually means you’ve either:
- Gone too long without making a payment, or
- Violated the terms and conditions of the loan
It takes a long time to default (federal loans take 270 days), but make sure to check your contract before you get started. If and when it does happen, however, the entire unpaid balance immediately becomes due, you’ll lose various benefits (repayment plans, deferment, forbearance, etc.), and the lender can report you to the credit bureaus, which will destroy your credit.
Defaulting on student loans isn’t the end of the world, but let’s just try to avoid that whole situation, OK? Life is simpler and more enjoyable that way.
Types of student loans
There are two types of student loans – federal and private. Federal loans are funded by the federal government, while private loans are offered by banks and credit unions. Here are some of the key differences:
- Repayment is delayed until you graduate, leave school, or change your enrollment status to less than half-time
- The interest rates are fixed and often lower than private loans
- You don’t need a credit check to qualify (except for PLUS loans)
- No cosigner is necessary
- There are various repayment and loan forgiveness plans
- Repayment plans can be changed after the loan is taken out
- Interest rates can be variable or fixed
- Loan forgiveness and forbearance (temporarily stopping repayments or reducing the monthly payments) are extremely rare and/or difficult
- Offer fewer repayment plans than federal loans
- Credit-based, meaning most students right out of high school need a cosigner
- Can be taken out by a student, parent, or guardian/relative/spouse
Understanding federal loans
There are three basic types of federal loans. Since federal loans don’t require cosigners, it’s important that the borrower does all the necessary research and understands what they’re signing up for.
Direct Subsidized Loans
If you’re an undergraduate with financial need, these loans are available to you. The major benefit of Direct Subsidized Loans is that the U.S. Department of Education pays the loan’s interest:
- While you’re in school at least half-time
- During your grace period (the first six months after you leave school)
- During deferment periods (temporary postponement of payments)
A deferment period is a temporary postponement of payments that happens under certain conditions. The difference between deferment and forbearance is that the borrower is responsible for paying the interest during forbearance, which may not be the case with a deferment.
Because a Direct Subsidized Loan is based on financial need, the amount you may borrow cannot exceed your financial need as determined by FAFSA. Your school determines the final amount.
Direct Unsubsidized Loans
Undergraduate and graduate students have access to Direct Unsubsidized Loans and financial need is not required. In stark contract to the subsidized loans, the borrower is responsible for paying interest at all times on these loans. You can choose not to pay the interest while in school and during grace/deferment/forbearance periods, but the interest will accrue and ultimately be added to the principal. Ouch.
The amount you can borrow is again determined by your school, but this time it’s based on your cost of attendance and other financial aid you receive.
Direct PLUS Loans
These loans are for students enrolled at least half-time at an eligible school leading to a graduate or professional degree or certificate, or a parent of a dependent undergraduate student enrolled at least half-time at an eligible school.
A credit check is completed as part of the process. If you have an adverse credit history, it’s unlikely that you’ll receive a Direct PLUS Loan.
Like the Direct Unsubsidized Loan, the amount given is the cost of attendance minus any other financial aid received.
Federal loan repayment plans and forgiveness programs
As stated before, the great thing about federal loans is the wide variety of repayment plans and forgiveness programs. I don’t want to bog you down in the details, so I’ll bring you right to the source.
Click here for a detailed breakdown of repayment plans.
Click here for applications and requests regarding repayment, deferment, forbearance, discharge and forgiveness, and loan rehabilitation.
Things to consider before taking out your loans
Whether federal or private, you need to read everything before signing any contracts (a good habit to keep) so that you understand your student loans inside and out. Overall, here are some of the most important things to keep in mind:
- Is this loan federal or private? How does that affect your options for repayment, forbearance, and forgiveness?
- What’s the interest rate?
- Is the interest rate fixed or variable?
- Who is servicing the loan?
- When are you required to make payments?
- What’s the penalty for late payments?
Going to college is a major milestone in your life and it carries broad financial implications. Like anything else, preparation is key to success. Just think of all the fun you’ll have once you’re finished with this whole ordeal!
Where are you in the student loan process? What concerns do you have? Let me know in the comments below!
All opinions expressed on this blog are solely those of Home at 30 and are in no way affiliated with any other organization or institution. The purpose of this blog is to give general education and information about investing, wealth, careers, and college; It is not intended to be professional advice.
Author: Josh Ramos
Josh has paid off $130k in student loan debt in 4 years. By founding Home at 30, he wants to help end the student debt crisis by helping students and young professionals make decisions that will reward them for a lifetime.