The Ultimate Guide to Student Loans

College students at graduation
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If you don’t have enough funds to pay for college tuition even after scholarships, grants, and financial aid, student loans can be helpful options to cover the gap. Student loans are designed to help you pay for educational expenses with borrowed money so you can make your dream of college a reality.

Though student loans have become the norm these days, there is still a lot of confusion on just how they work and what options are available.

What Type of Student Loans Are Available to Students?

If you need student loans, there are two options available to you:

  1. Federal student loans
  2. Private student loans

Federal student loans are offered by the U.S. Department of Education and are the loans that are available to you after you fill out a FAFSA (Free Application for Federal Student Aid). Currently, there are two federal student loan options available:

  1. William D. Ford Federal Direct Loan Program
  2. Federal Perkins Loan Program

Under the Direct Loan program, there are four types of loans that are available to students:

  1. Direct Subsidized Loan
  2. Direct Unsubsidized Loan
  3. Direct PLUS loans
  4. Direct Consolidation Loans

Direct Subsidized and Unsubsidized loans are available to undergraduate and graduate students who demonstrate need, while PLUS loans are available to graduate students or parents. A Direct Consolidation loan is available to students who are in repayment and want to combine their loans into a single monthly payment.

Private student loans are offered by banks and other financial institutions. Students who do not have enough federal aid to cover the costs of tuition may seek out private student loans to cover the gap in funding.

How Do You Get a Student Loan?

The process for federal student loans and private student loans are different.

In order to get a federal student loan, you need to fill out the Free Application for Federal Student Aid (FAFSA) by October 1. It’s important to note that there may be different deadlines for your state as well as your college.

Once your FAFSA is processed, you will receive your award package with the student loans that you are eligible for. In the meantime, you can use the FAFSA4caster to estimate what federal aid might be available to you.

When you get your federal student loan offerings, you will sign a Master Promissory Note, which is a legally binding contract that states that you will repay your student loans.

To get a private student loan, you will need to identify a local bank, credit union or financial institution that offers private student loans. Once you choose which provider you want to go with, you will need to fill out an application. Many private student loan providers require you to have a cosigner.

Typically, your parents may co-sign your loans, but it's important to know that co-signers are legally responsible for your student loans if you fail to make payments. When choosing a private student loan provider, see if they have co-signer release as an option.

Interest Rates on Student Loans

When you take out student loans, you are borrowing a certain amount to cover your tuition.

However, you will also pay interest, which can add up. Interest is charged by the lender as a percentage for the convenience of borrowing money.

Federal student loans have fixed interest rates which mean they will not change during your repayment. The interest rates are set by Congress each year.

Currently, federal student loan interest rates are:

  • Direct Subsidized Loan: 4.45 percent
  • Direct Unsubsidized Loan: 4.45 percent
  • Direct Unsubsidized Loan (graduate student): 6 percent
  • Direct PLUS Loans: 7 percent

While federal student loans have a fixed interest rate, private student loans, on the other hand, may have fixed or variable interest rates.  

Fixed interest rates remain the same over time, while variable interest rates may shift depending on market conditions. Each private student loan provider will have different interest rates.

The big difference between federal and private student loan rates is that private student loan interest rates are typically based on your credit. 

If you have good credit, you can score a lower interest rate. Typically students do not have much of a credit history, which is why most private student loans require a cosigner. If your cosigner has good credit, you may be eligible for a lower interest rate.

Interest can add to your student loan balance, so it’s important to understand how interest will impact your overall repayment. You can use an interest calculator to get a better idea of how your interest rate will impact your total balance.

Repayment Options

Student loans help you cover costs while you’re in school. Once you graduate, it’s time to pay back your student loans.

Most federal student loans have a six-month grace period where you will not have to make any student loan payments. So in other words, your first student loan payment will likely be six months after graduation — sometime in the late fall or early winter, if you graduate in the spring. If you can afford it, you can make payments during the grace period and cut down on interest. Private student loans may not have a grace period, and will depend on the provider. 

When your grace period is up, you’ll start your repayment journey. Your payments will depend on your repayment plan. Federal student loan borrowers are automatically enrolled in the standard Repayment Plan, which gives student ten years to pay back their loans. The good news is there are numerous federal student loan repayment plans and you can change plans at any time.

Here’s a closer look at federal student loan repayment options:

  • Standard Repayment Plan. Fixed payments over a 10-year period.
  • Graduated Repayment Plan. Payments start low and increase every two years over a 10-year period.
  • Extended Repayment Plan. Fixed or graduated payments over a period of 25 years.
  • Revised Pay As You Earn (REPAYE). Payments are 10 percent of your income and you can pay for 20 to 25 years. At that point, any remaining balance will be forgiven. Must qualify for the program.
  • Pay As You Earn Repayment Plan (PAYE). Payments are 10 percent of your income for a period of 20 years. At that point, any remaining balance will be forgiven. Must qualify for the program.
  • Income-Based Repayment Plan (IBR). Payments will be 10 to 15 percent of your income for a period of 20 to 25 years. At that point, any remaining balance will be forgiven. Must qualify for the program.
  • Income-Contingent Repayment Plan. Payments are based on 20 percent of your income or an amount that is adjusted to your income, whichever is less. The repayment term is 25 years. After that, any remaining balance will be forgiven. Must qualify for the program.
  • Income-Sensitive Repayment Plan. Your payment is capped based on a percentage of your annual income, which varies by lender, with a repayment term of up to 15 years. This option does not offer loan forgiveness.

Each of these plans has its own nuances and eligibility requirements, so it’s best to talk to your loan servicer to see which plans you qualify for if you’re looking to change plans. (Note: Your loan servicer isn’t necessarily the same as your lender. A lender is who provided your student loans, whereas your loan servicer is the company that manages your student loan payments.)

You will pay the least amount of interest if you stick with the Standard Repayment Plan and pay the most if you opt for an Extended Repayment Plan. If you’re worried about affording payments, an income-driven plan is your best bet to lower your student loan payments.

These plans cap your payment based on your income and in some cases can be zero dollars (yes, really). On top of that, they also offer student loan forgiveness after 20 to 25 years, which is attractive to student loan borrowers.

While student loan forgiveness is attractive to many borrowers, it’s important to note that you will pay tax on any forgiven student loans. The only forgiveness program where you won’t have to pay tax is the Public Service Loan Forgiveness Program, an option for student loan borrowers working in public service.

Private student loans have fewer repayment options and vary based on the lender. Since private student loans come from private financial institutions, they set the terms of repayment. It’s important to find out exactly what repayment options are available.

When it comes to choosing your repayment plan, you want to find something that works with your budget, so calculate your prospective monthly payments. Also, be realistic about how much interest you will pay with a certain plan. Shorter plans mean bigger payments, less interest while a longer repayment term will offer smaller payments, but you’ll pay more in interest.

If you want to change your repayment plan, or if you’re having issues making payments, contact your loan servicer right away to see what options are available.

What Happens If I Can’t Pay Back My Student Loans?

As a student loan borrower, you are required to pay back your student loans within the time frame set in your repayment plan. But what if you can’t afford to pay back your student loans? What then?

If you’re a federal student loan borrower, you have some options.

First, you’d want to see if you’re eligible for an income-driven plan. If you truly can’t afford to make payments, your payments could be zero dollars and you will be in good standing with your loans.

You can also consider deferment and forbearance as options as well. Under these options, you can put your payments on pause for a specified period of time. 

Your deferment options vary based on your situation, but you can defer your payments for up to three years if you’re unemployed or experiencing economic hardship. Under deferment, you may not have to pay the interest that accrues during deferment. 

By contrast, your loan will indeed accrue interest while under forebearance. There are two types of forbearance:

  1. General Forbearance
  2. Mandatory Forbearance

Under a general forbearance, you can postpone your payments for up to 12 months. Borrowers who are experiencing financial difficulty, a shift in their employment situation or unruly medical expenses may qualify for a general forbearance.

Mandatory forbearances are for students who meet certain requirements, like those in a medical or dental residency program or serving in the National Guard or Americorps. For those who qualify, you can postpone your payments for up to 12 months.

Whether you want to pursue a deferment or forbearance, you must apply for these repayment options with your loan servicer. You must also continue to make payments until you are approved for one of these options.

If you stop paying your student loans and don’t contact your loan servicer, your loans will become delinquent. After 270 days, your loans will enter default

Being in default can hurt your credit, and your loan servicer is entitled to garnish your wages as well as your tax return in order to pay back the loan. You want to avoid this, so always contact your loan servicer first if you can’t pay your student loans back.

How Can I Save Money on My Student Loan?

Student loans can add up fast and take a big bite out of your budget. If you want to save money on your student loans, what can you do?

Sign-up for auto-pay. Many loan servicers offer a 0.25 percent interest rate deduction if you sign-up for automatic payments. Of course, you want to make sure you have enough money in your checking account, to avoid things like overdraft fees.

Refinance your student loans. Your federal student loans have fixed interest rates. So what can you do if you’re unhappy with your rate? You can refinance your student loans with a private company or financial institution. Through refinancing, you pay off your old student loans and get approved for a new loan, hopefully with a better rate. Shaving off a few points on your interest rate can help you save money, making it that much easier to focus on your principal balance. However, refinancing federal student loans can come with downsides.

Opt for Public Service Loan Forgiveness. If you work in the public sector and make payments for 10 years, you may be eligible for Public Service Loan Forgiveness. Under this program you can get all of your loans forgiven. Bonus: You won’t be taxed on your forgiven loans, either.

Choose the Standard Repayment Plan. The Standard Repayment Plan has the shortest repayment term, which will help you save money on interest.

Pay more than the minimum. You will have a minimum payment based on your repayment plan. But you can pay more than that! If you can afford it, pay more than the minimum and save money on interest and get out of debt early.

Use the Avalanche method. The debt avalanche method zeroes in on high-interest student loans first, while paying the minimum on the rest. So for example, if you have loans for undergraduate and graduate school, you’d focus on paying down your PLUS loans first and pay the minimum on the rest. Paying down loans with the highest interest can save you money over time.

What Happens After I Pay Off My Student Loans?

When you make your final payment to your loan servicer, you want to make sure to include the interest as well. If you don’t, you might make what you think is your final payment, but then still owe a nominal amount in interest. You can also contact your loan servicer to say you want to pay back your loans in full.

Once you do, you should receive a letter from your student loan servicer stating that your loans are paid in full. Keep this letter for your records. After a month or two, you will want to check AnnualCreditReport.com to make sure it says that your loans are paid off on your credit report.

After paying off your student loans, you can celebrate and start putting your money toward saving and investing.