Most families rely on student loans to pay for college, but many don’t understand basics like the difference between federal student loans and private student loans, variable versus fixed interest rates, or how your choice of repayment plan can dramatically affect your total costs.
Taking some time now to understand the basics of student loans — how to take out a student loan and how student loans work — can save you money and a whole lot of stress down the line.
So we put together this guide to taking out student loans that will serve as your introduction to the world of student loans and borrowing.
This guide will walk you through how to take out a student loan for college and provide you with tips to understand your repayment options and help you lower your monthly payments.
If you’re someone who has already graduated college and are struggling with your student debt, this might be advice you wish you had gotten earlier.
Not to worry — you can still use this guide to help you put together a budget, and learn ways to manage your debt.
For those of you looking for even more information on how you can save money, check out our guide to student loan refinancing, which will walk you through the do’s and don’ts of refinancing and consolidating your student loans, and our guide to REPAYE, which breaks down the government’s newest income-driven loan repayment plan.
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Know before you owe
Heading off to college can be daunting. You’ll be navigating new academic challenges and social groups, and you may also be finding your way in an unfamiliar city. But more and more often these days, the hardest part about college is paying for it.
As college tuition costs rise, more and more students and their families are taking out loans to help pay for school. Seven out of 10 recent college graduates find themselves loaded down with student debt — $35,000 on average.
Dealing with student loan debt as you enter the real world can be overwhelming. This is why we believe the first step to successful borrowing and repayment of your student loans is education. We hope you’ll use this guide to minimize the amount of debt you take on, better understand how the loan process works, and be empowered to choose the best loans for you.
Getting started with student loans
Filling out the FAFSA
To be eligible for federal loans, grants and scholarships, you must fill out the FASFA, which stands for the Free Application for Federal Student Aid. The government will send your FAFSA application to the schools you’re applying to, and you’ll be offered an aid package from each institution.
The FAFSA consists of two sections — one that relates to free grants and scholarships, and another pertaining to loans. Depending on your situation, you may be offered one or more federal loans, and you are allowed to accept or decline any of the aid detailed in the aid package.
Before making your decision, be sure to try to maximize the free grants and scholarships first, and then look to the lowest-cost loan options.
You should also consider accepting federal work study, if available. Just don’t let work interfere with your academic success. If a combination of these non-loan options aren’t enough to cover your costs, first consider federal loans, and then private loans.
Federal loans vs. private loans
Many state agencies also offer student loans that are funded through the sales of bonds — these loans tend to have more in common with private loans than federal loans.
In general, financial aid advisors say students should max out on the most affordable federal loans before turning to costlier federal PLUS loans or private loans.
Federal loans offer borrowers many benefits and protections — such as loan deferment, forgiveness and repayment options — that private lenders generally can’t match. Rates on federal loans for undergraduates are also hard to beat.
Private lenders and state agencies may be able to beat the rates on government loans for graduate students and parents — particularly PLUS loans. Private loans are worth looking at once you’ve hit your borrowing limit for federal loans or have enrolled in grad school.
After graduation, your income and credit history may allow you to save money by refinancing your government or private student loans at a better rate with private lenders.
Interest rates on federal loans are always fixed, which means that once you take out a loan, the rate won’t change. Fixed-rate loans provide a measure of certainty, although your monthly payments on a federal loan can still go up over time if you choose an income-driven repayment plan.
While private lenders also offer fixed-rate loans, you can often get a lower rate with a private lender by taking out a variable-rate loan. Just remember that variable-rate loans can fluctuate in the future (for more on this topic, see “How to Choose Between a Fixed-Rate or Variable-Rate Student Loan.”)
Diving deeper: federal loans
Here are some of the main differences between subsidized and unsubsidized loans, which are also referred to as “direct” or “Stafford” loans.
- Features: With a subsidized loan, the government pays your interest while you are still in school and during a six-month “grace period” after you graduate. With an unsubsidized loan, you are responsible for the interest as soon as it starts accruing — even while you are in school. While unsubsidized loans are open to anyone, subsidized loans are only offered to undergrads who demonstrate financial need. Unsubsidized direct loans for graduate students carry higher interest rates.
- Eligibility: You are eligible for a direct loan if you are a dependent or independent undergraduate or graduate student.
- Application: Submit a FAFSA.
- Maximum allowed: The aggregate loan limit for dependent undergraduates is $31,000, and $57,000 for independent undergraduates. Either way, no more than $23,000 in undergraduate debt can be subsidized loans. For graduate and professional students, the limit is $138,000, of which no more than $65,500 can be in subsidized loans.
Until recently, students could turn to another type need-based federal loan, the Perkins loan. Perkins loans were subsidized, long-term, and came with low-interest rates. The loans were made with combined funds from the government and your school.
- Maximum allowed: Undergrads were able to receive $5,500 per year, totaling not more than $27,500. Graduate students could receive $8,000 per year, for a cumulative (undergraduate plus graduate school) maximum of $60,000.
Although Perkins loans accounted for only about 1 percent of student borrowing, they were an important source of funding for thousands of students. One analysis by the National Association of Student Financial Aid Administrators, estimated that 528,000 students took out Perkins loans in the 2014-15 academic year, with an average award of $2,198.
The Federal Perkins Loan Program Extension Act of 2015 was designed to phase Perkins loans out over two years, with the expectation that the entire student loan system would be overhauled by Congress before it ended. But the Perkins loan program was allowed to expire in 2017, and lawmakers are still working on a replacement.
Low-income students can take advantage of federal Pell grants, which aim to provide need-based grants to low-income undergraduate and certain graduate or professional students, in order to promote access to postsecondary education.
- Eligibility: You are eligible for a Pell grant if you are an undergraduate or vocational student enrolled in a participating school. Pell Grants are awarded usually only to students who have not earned a bachelor’s or a professional degree.
- Application: Submit the FAFSA.
- Maximum allowed: For the 2018–19 award year (July 1, 2018, to June 30, 2019), the maximum Federal Pell Grant award is $6,095. The amount you receive is based on factors such as financial need, cost of attendance, and whether you are a full-time or part-time student.
Federal PLUS loans
Lastly, parents of undergraduate student borrowers can take out federal loans on behalf of their children, if the students themselves are unable to qualify for a loan by themselves. These are known as PLUS loans, and are also available to graduate students.
While it can be helpful to be able to have your parents borrow on your behalf, keep in mind that interest rates on PLUS loans are higher than on subsidized and unsubsidized federal direct student loans, and also carry a one-time loan fee of nearly 4.3 percent.
- Eligibility: You are eligible for a PLUS loan if you are a graduate or professional degree student, or a parent of a dependent undergraduate student.
- Application: Submit the FAFSA.
- Maximum allowed: The maximum loan amount is the student’s cost of attendance (determined by the school) minus any other financial aid received.
If you were offered federal loans and want to accept them, you must go online and activate them (although some schools may require you to fill out a paper form). You’ll be asked to sign a promissory note detailing the loans’ terms and complete brief online loan counseling before the money goes from the government to your college.
Diving deeper: private loans
When it comes to private loans, terms and interest rates can vary depending on the borrower and the lender. While federal loans are standardized and everyone receives the same rates, private loans can be tailored to the borrower’s financial situation and credit history.
If you shop around and are able to prove your ability to repay the loan in time, you may be able to find low interest rates from private lenders.
While rates on federal student loans are always fixed, many private lenders offer borrowers a choice of a fixed- or variable-rate loan. While private loans that have variable interest rates will often seem like the best deal, interest rates can fluctuate, and it can be difficult for borrowers with variable rate loans to predict their monthly payments in the future.
Also keep in mind that private loans don’t always provide borrower protections guaranteed by federal loans, such as deferment, forbearance, and access to income-driven repayment programs that can lead to loan forgiveness. If you’re having trouble making your monthly payments, options like deferment and forbearance allow you to temporarily stop making payments on your loans.
Certain private lenders may offer similar benefits, so remember to check which options are available to you. As a rule, private lenders don’t offer loan forgiveness for public service, or the option of choosing income-driven repayment plans that allow you to make smaller monthly payments based on your income.
Applying for and accepting federal loans may be a tedious process, but in general, you should opt for federal loans and borrow as little as possible in the form of private loans. If you do have good credit, private loans can be an option for covering school and living expenses that exceed your federal loan limits. If you think you need to borrow more than federal loans will allow, consider a private loan, but do some research.
Things to remember
- Use a loan calculator to determine the correct loan amount for you, as well as the various repayment options.
- While you’re generally free to choose any private lender you choose, some schools may have a preferred lenders list. Remember that most student borrowers are required to apply with a cosigner, due to their lack of credit. Even if you do have some credit though, adding a co-signer could be incredibly beneficial. A qualified cosigner can help speed up a loan application and approval process, give you a better shot at being approved for a better loan and help snag you a lower interest rate.
- Remember to check the terms and details of each loan. Consider factors like fees, eligibility requirements (some private loans require you attend school for a certain amount of hours or make certain grades), and the number and amount of monthly payments you must make. Also, remember to check whether you will be allowed to begin repayment while still in school.
Managing your debt
While there are many ways student debt can trip you up, having loans can actually be beneficial. Not only can loans help you further your education and improve your chances of getting a well-paying job but, if you make timely payments, student loans can also help improve your credit score.
But never lose sight of the fact that a late payment can negatively impact your credit — and the credit of any cosigners you might have. Further, if you are unable to find work, or land a job that does not pay as well as you expect, you may find yourself unable to pay back your loans. To prevent this, only borrow the amount you need, and rely as much as possible on scholarships, grants, and income from working while in school.
If you find you have trouble repaying federal student loans, you should also explore options such as deferment or forbearance. Above all, you must avoid default.
Default is when a borrower simply does not meet his or her repayment obligation. If you have missed one or two payments, you are generally considered to only be delinquent — which basically means you are considered at risk of defaulting.
For most federal student loans, you will be considered to have defaulted if you have not made a payment in more than 270 days. Defaulting can result in serious consequences. If you default, your credit score will take a major hit. That could make it harder to borrow money, buy a house or car, or refinance your loans at a better interest rate.
In order to prevent the risk of default, do your research and plan ahead to ensure that you will have enough money coming in to always make your loan payments on time.
Consider refinancing or consolidation
Besides deferment and forbearance, there are other options — like loan refinancing or loan consolidation — that might be available to you. Consolidation lets you combine your government loans so you can make a single monthly payment.
You can also extend the term of your loan, at the same interest rate, which could lower your monthly payments but could mean you end up paying more in interest overall.
If consolidation is like getting your house professionally cleaned, you can think of refinancing as getting a whole new house. Refinancing is when you pay off your old loan, or loans, by taking out a new loan – typically at a lower interest rate. While a lower rate is good news, your new loan may not come with all the borrower benefits associated with government loans.
For more on how refinancing and consolidation can help you manage your student loans, check out Credible’s refinancing guide.
Consider repayment options and loan forgiveness programs
If you have federal student loans, you may be eligible for an income-driven repayment plan. These plans — including the most recent plan, REPAYE — make it easier for you to pay back loans, by determining your monthly payments based on your annual income, the size of your family, and the type of loan you have.
So you could potentially lower the amount you’re required to pay each month.
Another option that might be available to borrowers with federal student loans is loan forgiveness. These are programs that will cancel all or some of your student debt after a certain period if you are deemed to be providing some public service. These include forgiveness programs for some teachers and nurses.
Planning your debt
Most student loan providers will give you up to six months post college graduation before you must start repaying your loans. This should give you more than enough time to plan your budget and take the necessary steps to help with your financial tracking.
Here’s a look at how you can plan ahead when you begin repaying your loans.
Determine your budget
When planning your budget, you should first determine your income sources (wages, tax refunds, family support etc.), and amounts, as well as your fixed and variable costs — list out realistic monthly costs!
Fixed expenses: rent, cable/internet, insurance, cell phone etc. Variable expenses: Groceries, shopping, gas, credit card balances etc.
Determine monthly loan balance
If you have private loans and do not see these on your NSLDS ledger, contact your school’s financial aid representative to help you locate lender information. Another solution is to look for your loan distributors through your credit reports. You can get a free credit report here.
Reconfigure budget with loan payment
Once you have your student loans factored into your fixed expenses budget plan, take a second look at your budget and determine where you stand. If you find yourself in the red, look into the repayment options outlined above, as well as into loan refinancing or loan consolidation.
Remember: The more you know, the better prepared you’ll be in the future. Student loans will relieve you from the burden of finances while you’re in school, and taking responsibility now to account for your loan balances will reward you in the long-run. So what are you waiting for? Use our budget planner and start planning!
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Ariha Setalvad <email@example.com> is a Credible staff writer. Follow us on Twitter at @Credible.