What is a student loan?
A student loan (also known as an education loan) is intended as a source of financial aid for people receiving post-secondary education, especially higher education. Student loans help students pay for tuition and associated expenses such as accommodation, books, study supplies, and basic living expenses.
Unlike most loans, they have a considerably long grace period. Student loan borrowers are usually exempted from making payments until they acquire their degree and sometimes are even given additional six free-of-payment months.
What are the major types of student loans?
Two major student loan categories are federal loans and private student loans.
Federal student loans
The government provides federal loans, and these loans generally have safer conditions than bank-offered ones. There are three types of federal student loans:
Direct subsidized loans
Subsidized loans are designed for people with financial needs. The government covers interest payments on these loans during the grace period, your studies, or if you requested deferment and have a pause from repaying the loan.
Direct unsubsidized loans
Both undergraduate and graduate students are eligible for this loan. You don't have to demonstrate financial need, and therefore, you don't have any exemptions from making interest rate payments.
Direct PLUS loans
Subsidized and unsubsidised loans have limits and can cover the tuition fee partially. Direct PLUS loans are for graduate students and parents of undergraduate students who need additional financial aid.
Grad loans are for Master's students and professional students who need to borrow more than the federal unsubsidized loan limit. To qualify for this loan type, you need a good credit history, and borrowers with a record of significant debt or even bankruptcy can be rejected.
Parent loans are for parents of undergraduates who are dependent on their financial support. To qualify, they also need to undergo a credit check.
Consolidation loans
Several federal education loans can be consolidated, meaning that you will not have to pay multiple lenders in separate ways and will have one joint bill. Loan consolidation can decrease your monthly payment by extending the repayment period for as long as 30 years, and you can choose to set fixed rates on the loans you pay instead of variable rates.
Whereas there are certain advantages, consolidation can also mean that you will pay more in interest overall and lose borrower benefits on some loans. That is why you are allowed to choose which loans to consolidate and can decide not to make one bill for all of them.
Private student loans
Financial institutions such as banks and credit unions offer private student loans. They can be helpful if your federal loan of choice doesn't cover the total fees or particular circumstances. There are several types of private student loans suitable for different scenarios. Here are some of them:
Law school loans or bar exam loans are designed to cover unusual expenses during the bar exam preparation period. Students can use them to pay for living expenses, preparation classes, and exam application fees. Bar loans have a higher interest rate and a possible repayment period of up to 20 years.
Bootcamp loans are designed to cover coding Bootcamp costs. Different personal loan providers offer them, and these loans generally have lower interest rates and convenient repayment options.
International student loans are naturally meant for non-citizens studying in the U.S. who are not eligible for federal student loans and can only count on private lenders. Foreigners are required to take out loans with an American co-signer.
How to apply for a student loan?
While it is up to you which loan to choose, we recommend going through a complex application process of considering all the options to make an informed and reasonable choice.
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Free Application for Federal Student Aid. First of all, we recommend filling out the government's FAFSA form. It will analyze your Expected Family Contribution and estimate the federal financial aid you can receive.
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Compare award letters. The colleges you applied to will offer you different financial aid packages based on the information you provided in FAFSA. Essential points of comparison are the amount of money offered and loan conditions (subsidized/ unsubsidized).
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Private student loan application. If federal student loans don't cover your expenses fully, you might want to consider private loans. They lack some of the federal aid advantages: they have variable interest rates, cannot be consolidated, and are typically more expensive. However, private student loans offer higher limits for borrowing money. You can fill out a standardized form on the financial institutions' website or at a physical location to apply for a private student loan.
What are the main requirements for getting a student loan?
To meet basic federal student loans requirements, the applicant should:
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be a U.S. citizen or permanent resident
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be accepted to/ enrolled as a student with any eligible degree program
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have a Social Security number
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demonstrate academic progress and show that they are qualified to obtain the degree
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are not in default on previous federal student loans
The list of private student loan requirements is slightly different:
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be a U.S. citizen or an eligible noncitizen (such as permanent resident, asylum-seeker, refugee, etc.)
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be accepted to an eligible educational institution
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have sufficient credit history
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have a co-signer to apply with (if needed)
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plan to use funds for education-related expenses
If you struggle to provide a decent credit score, you can apply for the loan with a creditworthy co-signer. It is a person who shares the responsibility of repaying the loan with you and can step in if you fail to pay it back.
Ways to get a student loan
As we mentioned above, federal student loans have limits. Undergraduate borrowers can typically take out no more than $12,500 per year, and graduate students can borrow up to $20,500. These funds are usually received in the following way:
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The money is disbursed to the chosen university and used to cover all institutional expenses (such as tuition and housing).
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The rest is transferred to the borrower's bank account and is meant to be used for essential supplies and living expenses.
The maximum loan amount forprivate loans can vary from $20,000 to $500,000, depending on the lender and loan term.
As well as federal loans, private student loans are partially disbursed for essential education expenses.
How to repay a student loan debt
Federal student loans
The standard repayment option is the default plan for making student loan payments. If you choose this plan, you will have to make monthly payments for ten years. This option is suitable for borrowers who want to have a lower interest rate and pay less overall, and they will have to make 120 payments with fixed rates.
Borrowers, who wish to repay the loan faster, can make early payments or make overpayments. There is no penalty for paying extra, but it can save you a lot of money and free you of your debt faster than planned.
Income-driven repayment plan is based on one's discretionary income. It has flexible payment terms, with every month's loan payment being 10%-20% of your income. The sum you need to pay can be as small as $0 and change every year in the 20 to 25-year loan term.
This option will allow lower monthly payments, but you will pay more interest.
Student loan forgiveness allows government employees and certain people who work in the non-profit sector to stop paying back after making 120 loan payments. The public Service Loan forgiveness program can benefit borrowers on an income-driven repayment plan. After making 120 payments, they will still have a remaining loan balance that can be forgiven.
Private student loans
- Signing up for autopay allows your lender to deduct installment payments from your bank account. It is beneficial because it implies an auto pay discount that can add up to a small sum of money saved.
- Refinancing the loan can turn several student loans into one private loan with shorter terms and higher monthly payments but a decreased overall interest.
- Biweekly payments instead of monthly payments are a way to cut your interest and repayment time by making regular extra payments.
- A basic repayment scheme of paying monthly installments for a fixed period can be an option if you do not find the aforementioned methods significantly beneficial.
Pros and cons of a student loan
Student loans have significant advantages and disadvantages to consider.
Pros
- You can afford higher education. Annual college expenses (including tuition, accommodation, and board) can be up to $50,000. Not every U.S. citizen can afford such a price, and a student loan for many people means opportunities for a better future career and higher income.
- They support academic excellence. Private colleges generally offer a more outstanding quality of education. That being said, they can cost twice as much as public colleges. If a student shows exceptional academic results, it can be an opportunity for them to multiply their merits and knowledge.
- They can be used to build good credit. Since student debt is often the first type of debt a person has to deal with, it can be used to improve credit score if the borrower pays it off responsibly.
Cons
- High additional cost. To repay loan debt, you need to pay back the initial amount you borrowed plus additional fees and interest. Rates on federal loans are 6% on average, and private lenders usually offer even higher rates of around 12%.
- Inevitable debt. Once you graduate, you will owe your creditor. Repaying student debt can postpone multiple life-important investments and purchases and cause significant psychological pressure.
- No way out. If you do not make your loan payments for more than 270 days, it would mean that you defaulted on your loan, and it would cause damage to your credit history. Moreover, student loans are hard to get rid of by declaring bankruptcy, unlike other loans like a mortgage.
Legal regulation of the student loans in the USA
Different states tend to clarify legal student loan regulations and protect loan borrowers' rights. Thirteen states, including California, Colorado, Connecticut, District of Columbia, Illinois, Maine, Massachusetts, Maryland, New Jersey, New York, Rhode Island, Virginia, and Washington have introduced the Student Loan Borrower Bill of Rights.
This bill's set of regulations varies from state to state but is generally designed to prevent students from being deceived and ensure that they secure a safe and beneficial repayment program. An average Student Loan Borrower Bill of Rights can include the following points:
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prohibits fraudulent and deceptive practices such as omission and invalid representation of essential financial information
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ensures student's rights to detailed and open communication with education providers regarding students loans
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limits late fees at a reasonable percentage of the amount past due
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education providers (or other organizations) must respond promptly to different complaints
To file a complaint, you need to contact one of the following organizations: lender, student loan servicer, state attorney general, state education department, the U.S. Department of Education, Consumer Financial Protection Bureau, or Federal Trade Commission.
As more and more states implement the bill, we are getting closer to the federal student loans bill of rights, ensuring protection for all U.S. citizens.
The real cost of a student loan
- Federal student loans consist of 3 key components: the principal amount, origination fees, and interest rate.
- The principal amount equals the amount of borrowed money.
- Origination fees are charged when the loan is first borrowed. Direct subsidized and unsubsidized loans usually have a 1% fee, while federal PLUS loans fees can be up to 4%. For a $10,000 loan, you will have to pay an extra $100 with a 1 percent fee or an extra $400 with a 4% fee.
- Interest rates are charged by the lender for the money you get. Federal loans typically have a fixed rate, meaning that you will pay the same additional sum every month. The longer you extend the payment period, the more the overall interest you will pay. A $10,000 loan with a 5% rate will cost you about $1000 in interest if you pay it back in 2 years.
- Borrowers eligible for subsidized loans have a break from paying interest during the academic year or for other valid reasons (e.g., military service).
- Unsubsidized loan borrowers usually have a grace period during every academic year, but that doesn't exempt them from accumulating interest. For example, a student with a $20,000 loan graduates from college and enters a repayment period. You got an additional $4,000 of interest during four years of studies. Once you start paying back, you will have to pay capitalized interest for $24,000.
- Private student loans usually do not include origination fees, so their formula is the principal amount + interest rate. Private lenders, unlike federal, sometimes offer variable rates that depend on various economic factors and change annually. That can mean lower interest rates for borrowers and risk of interest increase.
