no money college kid

Understanding Student Loans

It is highly likely that you will end up graduating college with at least some student loans. Because of the cost of college today, the amount of student loans you graduate with will be something you’ll have to think about for years or decades after graduation, so it’s a good idea to know what you’re getting into. We’ll walk you through the types of loans, tips for the FAFSA, and types of repayment plans.

Types of Loans

There are two types of student loans: federal and private. Federal loans come from the U.S. government and come in three different forms: direct, direct PLUS, and Perkins. If you have a high school diploma you likely qualify for federal loans. The interest rates on most of  these loans are set by Congress each year (except the Perkins loan, which is explained below).

  1. Direct loans
    1. Direct subsidized (or subsidized Stafford) loans are designated for undergraduate students with a financial need. You do not need to worry about any interest accrued while you’re in school with these types of loans.
    2. Direct unsubsidized (or unsubsidized Stafford) loans are the most common loans and are available to both undergraduate and graduate students. Unlike their subsidized counterparts, they do accrue interest while you’re in school, which you will see added onto your balance after your grace period. More information on grace periods is below. Make sure you factor in the interest on these loans, so you aren’t surprised when the amount borrowed goes up upon graduation, due to the capitalization of interest.
  2. Direct PLUS loans
    1. Grad PLUS loans, like private loans, take into account your credit scores. They are available to graduate and professional students and come without borrowing limits.
    2. Parent PLUS loans are for parents of undergraduate students. They also do not have borrowing limits, but, again, are dependent upon excellent credit histories.
  1. Perkins Loans – Perkins loans are also subsidized loans undergraduate students with extreme financial need. These loans always charge a 5% interest and do not include fees. However, after September 30, 2017 these loans will no longer be available.

Private loans, on the other hand, come from private banks and financial institutions, and you qualify for these based on your credit score. Because of this, you will likely need to apply for a private loan with a parent or guardian. Typically, private loans come with a much higher interest rate and less flexibility for repayment plans than federal loans. Private loan interest rates are based both on credit scores and the economy.

Grace Periods

Most federal loans give you six to nine months after graduation before you must begin repayment. Some private loans may also offer a grace period, though typically a shorter one. Note that your unsubsidized loans will continue to accrue interest during this period, however.

Repayment Plans and Loan Forgiveness

Federal loans default to a standard 10 year repayment plan upon graduation. This plan gives you a fixed amount each month for the next decade, but depending on how big your debt is and how much you’re making that amount can be prohibitive. Thankfully there are other options, which are offered through your loan provider or the Department of Education’s student loan website. You have flexibility to switch between plans at anytime, depending on what you initially borrowed, your current income, and your family size. These other plans are income-driven, which cap your payment at a particular percentage of your current income, usually 10-15%. However, because you are making smaller payments, your repayment terms increases from 10 years to 20 or 25, meaning your are paying more on interest in the long run. Use the Department of Education’s Repayment Estimator to help you figure out what you’ll pay with each plan.

There are four types of income-driven plans:

  1. Income-based repayment: good if you have a lot of debt compared to income and took out your loans after July 1, 2014.
  2. Pay As You Earn: good if you have a lot of debt compared to income and took out loans after September 30, 2007 and again after September 30, 2011. Very few qualify for this option.
  3. Revised Pay As You Earn: good if you have undergraduate loans and can’t afford payment on the standard plan, or if you have graduate loans and don’t qualify for options 1 or 2. Not likely a good option if you are married, because your monthly payment is determined by both your and your spouse’s combined incomes, regardless of whether you file taxes separately or not.
  4. Income-contingent repayment: good if you have Parent PLUS loans and can’t afford payments on the standard plan, but can pay more than on options 1-3.
  5. Graduated repayment: good if you can’t afford the standard plan and you expect your income to steadily increase over time. Your repayment term remains at 10 years and will increase every two years, regardless of whether your income does or not.
  6. Extended repayment: good if you can’t afford the standard plan and want fixed monthly payments. This extends your repayment plan to 25 years to make monthly payments easier, but also means you are payment much more on interest in the long-run. You can also choose to make graduated payments with this option.

If you work in certain professions, you could have federal loans forgiven after 20 or 25 years of payments. Through the Public Service Loan Forgiveness program, if you work at a nonprofit, as a teacher, or at a government agency your loans can be forgiven in as little as 10 years.

FAFSA Is Your Friend

In order to qualify for any federal loans you must first fill out the Free Application for Federal Student Aid (FAFSA). Based on your FAFSA, the government decides how much you (or your family) can reasonably pay towards your college.  The difference is then covered by a mix of loans, grants, and/or scholarships, as recommended by the schools you are accepted to. The FAFSA is available for the next academic year beginning in October (starting in October 2016) each year. You’ll want to start the process during your senior year of high school, as the earlier you fill it out the more aid you are likely to receive from limited funding sources, such as Work Study.

Before you begin filling out your FAFSA, there are a few things to make sure you have.

  1. FSA ID: If you are a dependent student, know that you will need information on your parents’ finances. Your parents will also need to apply for a Federal Student Aid ID (FSA ID) for you. You’ll need this ID before you can begin filling out the FAFSA, but should only take a few minutes to get.
  2. Documents: You (and your parents, if you are a dependent) will need to have your:
    • Social Security Number or Alien Registration Number (if you aren’t a U.S. citizen)
    • Last year’s tax returns, W-2s, and any other records of money earned. Depending on when you file your taxes and apply aid, you might be able to use the IRS Data Retrieval Tool [link: https://fafsa.ed.gov/fotw1718/help/irshlp9.htm] , which lets you transfer your tax returns directly to your FAFSA.
    • Bank statements and records of investment (if applicable)
    • Records of untaxed income (if applicable)
    • FSA ID

Understand Your Financial Aid Award Letter

Upon acceptance to a school you will receive a financial aid award letter. While these letters will include any scholarships or grants the school might offer, it also includes loans you qualify for. Make sure you understand exactly which aid is essentially free money (scholarships, waivers, and grants) and what is actually loan money. Your letter may or may not include the total cost of school. Some may only include the cost of tuition, but not room and board, books, other fees, etc, which add up. If this information is not provided, do your research so you are able to properly determine how much is actually being offered and which school is giving you the best deal.

Note that just because you are offered a particular amount in scholarships, grants, or other “gift” amounts one year does not mean you will receive the same thing next year. Make sure you understand how any aid from the school may change from year to year, as this will impact what you’ll need to take out in loans.