Student Loans 101-- Everything You Need To Know

Student Loans 101 – Everything You Need to Know

If you’re looking to attend college—or are attending now—chances are good that you’ve also looked at student loans. They’ve become nearly a guaranteed part of the total college experience with the rising rates of tuition.

The average cost of tuition has almost tripled at all school types in the past 20 years, and the idea of getting a job and working your way through school isn’t as easy as it once was. Almost three-quarters of students graduate with debt and the average student loan debt is about $37,000.

What does it mean to get a student loan and how does it help you? Perhaps even more importantly, how can it hurt you? How can you smartly plan for college?

What are Student Loans?

If you’re familiar with how loans work—borrowing money and agreeing to pay it back with interest—then you already know a bit more about student loans than you think. In that sense, student loans are no different than other types of loans that you may get, such as for a vehicle; you borrow money to pay for college, and then make payments with interest to the lender.

Student loans are different in one major aspect, however. With most other loans, you start repayment right away; with most student loans, you don’t have to start repayment 6 months after you graduate or leave school. In case this all sounds a bit confusing, let’s go over some definitions.

Basic Student Loan Terminology

There are several terms that will make understanding student loans a bit easier, and that translates to being able to navigate the landscape.

Interest – The cost of borrowing money, or how the lenders make a profit. It’s usually expressed in a percentage called the Annual Percentage Rate. If you borrow $10,000 from a lender, for example, you will end up paying back the $10,000 plus an extra percentage of that amount, which goes to the lender directly and serves as the lender’s profit. The extra amount you will pay is determined by the interest rate, which is applied to the outstanding balance on a daily, weekly, or monthly basis.

Term Length – This is the length of the loan, or how long you have to pay it back. For student loans, it’s usually 10 years, but can be extended in certain circumstances.

Principal – The amount you borrowed or have left of the balance. When you make a payment on your student loan, the payment is split; some goes to the interest, and some goes to pay off your original balance.

Default – If you don’t make your payments, or fall behind, you could be placed in a default status on your student loans. At the very least, being in default will negatively affect your credit rating; if you have federal loans, it could affect your income tax returns and ability to receive other government services.

FAFSA – The Free Application for Federal Student Aid is one of the criteria for getting many types of student loans as well as other types of financial aid. The FAFSA lists you and your family’s income, tax responsibilities, and gives an overall picture of your finances. Based upon your financial need as shown in the FAFSA, the government will decide how much money you need to be able to contribute toward your own education, and then your school will decide how much financial aid you will be awarded. Part of that financial aid will include student loans.

Now that we’ve gone over some terms, let’s take a look at the two major types of student loans and how they work.

Federal Student Loans

This type of student loan is granted or backed by the federal government and account for around 90 percent of student loans taken out nowadays.

After you’ve filled out your FAFSA, and the government has determined your expected contribution, it notifies the school of your choice of the amount. The school then offers you a package of financial aid which may include scholarships, grants, and student loans.

The government, through the Department of Education, offers Direct Loans to borrowers, in which they are the lender. If you get a direct loan from the government, you’ll be making your payments to a loan servicer company that the Department of Education dictates. Also called Stafford loans, these are further divided into subsidized and unsubsidized loans; what type you have dictates whether you or the government will be paying the accrued interest while you’re in school. The government pays the interest during school and periods of deferment on subsidized loans but not unsubsidized loans.

Another type of federal loan is called a Perkins Loan. Here the school is considered the lender instead of the government, even though the loan is still a federal one. The Perkins Loan also has a longer grace period after graduation before repayment must begin—9 months as opposed to the 6 months most other loan types offer.

The last type of federal loan is a PLUS Loan and it’s only available to you if you’re a graduate, post-graduate, or professional student—or if you’re the parent of an undergraduate student. The PLUS Loan is based on creditworthiness and is not eligible for many of the repayment options that come with most federal loans.

Interest rates on federal loans can vary depending on the type of loan, and the type of student you are. Undergrads pay about 4.45% APR on a direct loan, with graduate and professional student paying 6% on an unsubsidized loan. For PLUS Loans, the interest rate is higher—7 percent.

The first step in getting a federal loan of any kind is completing a FAFSA and talking to your school’s financial aid office. You can also visit studentloans.gov.

Private Student Loans

Private loans differ significantly from federal. First, private loans are offered through banks and other traditional lenders. That means they are wholly based upon your creditworthiness as a borrower; if you’re a student with a limited credit history, you’ll need a co-signer to qualify.

Because private student loans are not much different from other types of loans you’d get from a bank, your interest rate is also based upon your credit score and ability to qualify. If your score is 690 or below, for instance, you can expect to see higher interest rates than an applicant with better credit.

In addition, you can choose between a fixed interest rate or a variable rate. Variable rates can fluctuate with the market, which means even if you get a low variable rate now, that rate can increase over the course of the loan. Fixed rates will stay the same over the life of the loan.

You may also be expected to start paying back your loan before you graduate. Some private lenders expect repayment to begin immediately, just like a car loan—except in some cases, they’ll allow you to make interest-only payments or partial payments until your graduation.

Private loans are usually far more expensive than federal; you’ll want to make sure that you’ve exhausted other options before looking at private student loans.

Tips for Repayment

Regardless of where you borrow the money from, you’ll want to pay it back on time. Depending on the type of loan, you’ll have options ranging from income-based plans to deferment to even possible forgiveness or consolidation. To keep your amount of interest paid low, you can make biweekly payments or refinance to a lower rate after graduation.

The single most important point about student loans, however, is making sure that you stay in touch with your lender if you run into problems and need to discuss options. If you plan well, and stay on schedule, student loans can empower your or your child’s dreams instead of hold you back.

By Tom – a millennial personal finance blogger specializing in debt payoff, financial independence, and early retirement. Follow him on Twitter @FIREdUpMillenn.

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