Complete Introduction to Student Loans

Several months ago I saved a very insightful Reddit post titled "Student Loans 101" to my Documents folder. Several days ago I attempted to revisit this page and discovered it was permanently removed. Most modern families have some type of exposure to student loans. You have highschoolers that are considering college. Thanks to student loans, maybe you are currently attending a school. Or, maybe you are still paying off your own student loans (in the repayment period).

I've come to realize a very scary thing. No one educates the general public about the crucial student loans information. As a whole, most people's knowledge is very incomplete. Some of the same common questions get asked over and over again.

Types of Student Loans

Largely relying on the structure and information from the removed post, this article will cover student loans from the beginning to the end. Starting from the top, this is how you should first prepare for student loans: by familiarizing yourself with the different types of student loanoptions. There are two broad classes of student loans:

1. Federal Student Loans
2. Private Student Loans

Each type of loan has several subcategories. They are all covered and explained in further detail below.

Federal Student Loans

Sticking to federal loans is usually the best choice for most would-be students. It doesn’t matter if you’re 16 or 60 The very first thing you should do when you’re getting ready to start college is to fill out the Free Application for Federal Student Aid otherwise known as FAFSA. I could write another whole guide on the FAFSA but for now, what’s important about it is that you fill it out to the best of your ability. Just about every U.S. citizen who graduated high school/has their GED, signed up for the Selective Service (males), and hasn’t been convicted of selling drugs will likely qualify for some type of aid, unless you or your parents make boatloads of money.

Federal Perkins Loans

The FAFSA will tell you if you are eligible for a Federal Perkins Loan or a Stafford Loan. Perkins loans are doled out by your school (not all schools are in the program) and have a fixed interest rate of 5%. The government is actually moving to phase out Perkins loans with the last available ones being given by September 30, 2017. Your school will apply whatever amount you get to your bill for tuition and boarding. Sometimes, there will be some extra leftover, which will come back to you in the form of a check. Since these loans are being phased out in less than a year, there isn’t much else to say about them until it comes time to repay them.

Stafford Loans

These are the loans you may end up with if your parents’ expected financial contribution is fairly low. There are two versions of the Federal Stafford Loan

• Subsidized Stafford Loans - Interest on a subsidized loan doesn’t kick in for you until after the 6 month grace period for repayment. Technically, it does accrue but the government subsidizes it by paying the interest for you. These are usually given to those coming from lower-income families.
• Unsubsidized Stafford Loans - Interest starts accruing immediately but you aren’t required to pay it while you are in school. Once you graduate, all of the interest that has building up since you started school will be added onto the principal of the loan.

Interest rates on these loans can vary depending on when they were first given to you and whether you are an undergraduate or graduate student. Grad students can still get Stafford loans, but they can expect to pay a higher interest rate, usually around 5%.

PLUS Loans

PLUS loans are taken out by your parents, in their name only, to help you pay for school expenses. Most of the time, they are only taken out when Stafford and Perkins loans aren’t enough to cover everything school-related. You tend to see them more with schools that have a higher cost of attendance.

Unlike those two loans however, the interest rate is 7.9% and your parents’ credit history does play a role in whether or not they qualify for a PLUS loan.

Pell Grants

Though this isn’t a loan, your loans through your FAFSA are likely going to be based around how large of a Pell grant you receive. You don’t need to repay this grant and can get up to $5,815 for the upcoming school year. In reality, you will probably receive far less than the maximum, which is usually reserved for students who come from extremely low income families. If you receive a full ride scholarship of any kind (athletic, academic, essays, etc.) you are not eligible to receive Pell grant funds.

Those are your main federal loan options, but you might be able to find some state-specific loan options if those aren’t enough.

Private Student Loans

For some students, private loans need to be taken out to cover the cost of attending college. This is usually because their parents make too much money to be awarded very much in the form of financial aid and their choice of college is relatively expensive. You might find a lot of graduate level students in this same boat, mainly because government options start drying up once you get your Bachelor’s degree.

Facts About Private Student Loans

Student loans from a private lender work in much the same way as a government student loan as far as paying for school goes. However, there are also some major differences.

• Interest rates can vary widely - There are some private student loans that have interest rates well below PLUS loans. On the other hand, you could end up with a ridiculous interest rate of over 10%. It all depends on a variety of factors.
• Your credit score is taken into account - Public lenders don’t look at your credit score, but they might look at the credit history of your co-signers. Private student loan lenders will usually take your credit score into consideration when deciding whether or not to give you a loan, and what kind of interest rate you’ll get. You can find a good baseline credit score at Credit Karma or Credit Sesame.
• You cannot (usually) discharge them in bankruptcy - Like federal student loans, you won’t be able to get rid of private student loans just because you declare bankruptcy. There are certain conditions that will warrant a discharge, which I will talk about below.
• There are no cancellation or forgiveness programs - Going into certain professions with federal student loans gives you the chance to have them forgiven or cancelled. This is 100% NOT the case with private student loans. At the end of the day, a private lender is out to make money, cancelling a loan because you became a social worker won’t fly for them.
• There is no income-based repayment plan - You’re stuck with your monthly payment whether you make $28,000 a year or $228,000 a year. Private lenders generally will not adjust your payments based on your income, unlike federal loans which can fluctuate to match what you can afford.

That’s the gist of the difference between federal and private student loans. Obviously, federal loans are almost always going to be the best option since there is a lot of flexibility around who can qualify for them and repayment plans.

Repaying Student Loans

Once you’ve graduated or started going to school as less than a part-time student, you’ll usually have a period of time, between 6-9 months, when you don’t have to repay your student loans. This is called your “grace period” and interest can still build up on the time between graduation and repayment.

In a perfect world, we would all be able to make 10 years (or less) of payments after the grace period ends and be completely student loan free. In reality, some people can afford to put much more than their monthly payment towards their loans while others cannot come close to affording their monthly payment.

Federal Student Loan Repayment Programs

Aside from the standard 10 year repayment plan, there are a few other options which can help with your monthly payments depending on your expenses and how much you make.

• PAYE Plan - Pay As You Earn - If your first federal student loan was disbursed after September 30, 2007, you can repay your loans under the PAYE plan. With this, your maximum monthly payment is capped at 10% of your discretionary income (more on that here) as long as it’s less than what you would normally repay on a standard 10 year plan. Your repayment schedule will stretch out to 20 years under this plan, but you can still have your loans forgiven under the Teaching/PSLF programs after 5/10 years.
• REPAYE Plan - REvised Pay As You Earn - Unlike the PAYE plan that requires you to have a qualifying income, anybody can elect to pay under the REPAYE plan. 10% of your discretionary income would be your maximum monthly payment over a period of 20 years (unless part of the loans were used for graduate studies, then 25 years). As with the PAYE plan, you can qualify for forgiveness after 5 or 10 years if you work in certain professions.
• ICR Plan - Income Contingent Repayment - This is the only repayment plan available for PLUS loans, though they must be consolidated first. Payment caps are 20% of your discretionary income or what you would normally pay on a 12 year schedule at a fixed rate based on your income, whichever is lower. Anyone can qualify for an ICR plan and your term will be extended to 25 years. Federal forgiveness/cancellation options are still available once you’ve made the required number of payments/worked for a certain amount of time.
• IBR Plan - Income Based Repayment - Similar to the PAYE plan for those who receive their first loan after Sep 30, 2014, your payments are capped at 10% of discretionary income but never any more than what you’d pay under a standard repayment plan. For those who received loans before that date, it’s capped at 15% and no more than a standard repayment amount. Loan terms are 20 years for those starting after Sep 30, 2014 and 25 years for those before that date. As with other plans, you can still have loans forgiven under Public Service Loan Forgiveness (PSLF).

Options When You Cannot Repay

Federal student loans do have some flexibility when it comes to being unable to make your monthly payments. Some of them only take place in a limited timeframe, other repayment options can extend indefinitely.

• Deferment - During a deferment, you don’t have to pay principal or interest on a student loan but the interest does keep racking up. If your loans are subsidized, the government pays the interest during a deferment. There are several reasons why you can apply for a deferment, but the ones that apply to most people are the economic hardship and inability to find employment deferments, each lasting up to 3 years.
• Forbearance - Similar to a deferment, you don’t have to make payments while your loan is in forbearance, but it does still accumulate interest. You can request a forbearance if you otherwise wouldn’t qualify for a deferment, but in many cases it’s up to the lender to decide whether or not to grant it. In some cases, they are required to grant the forbearance, usually if your student loan payment would make up 20% or more of your gross income.
• Consolidation - There are times when an unmanageable situation occurs that would be fixed if several loans were consolidated. This often results in a lower monthly payment and a fixed rate, but at the expense of having to repay for a longer period of time. The federal government lets you consolidate several types of public student loans into a new loan, but prohibits you from rolling private loans into your federal consolidation. It’s also possible to get a private consolidation loan that would pay off your federal loans, but you lose all the flexibility you enjoy with federal programs when you do this.
• Bankruptcy - Discharging your student loans in a bankruptcy is possible but it doesn’t happen very often. In order to do this you typically have to show that your student loans alone would put you in an untenable financial situation for a long period of time. This means if all of your other debt were wiped out in a bankruptcy, your student loan payment would have to be so high you still wouldn’t be able to support yourself. Few people get their student loans discharged through bankruptcy, those who do are sometimes under unique financial stress.

Forgiveness and Cancellation

Some people may be eligible to have their federal student loans forgiven or cancelled. Though there are many reasons which can result in the loan completely disappearing, becoming a teacher or entering a public service profession are the two most common ways to receive loan forgiveness.

Perkins loans are forgiven on a graduated scale for public service professionals, sometimes resulting in 100% of the loans being forgiven. Other types of federal loans can be forgiven after 120 on-time regular payments while you are employed in the public service sector. Teachers have a special carve-out that only requires them to work 5 years in a low-income school to qualify for loan forgiveness.

Overpaying Your Student Loans

If you think you’re going to be eligible for public service/teacher loan forgiveness programs, it’s usually in your best interest never to overpay your monthly payment. You won’t get credit for the extra money you put into the loan when it’s time to have it forgiven.

Student loan debt usually accumulates interest at a lower rate than most other types of debt. Pay off things like your credit cards first before trying to knock out student loans. Car loans and mortgages can sometimes have rates higher than your student loans, but paying your student debt faster can free up your monthly payment to go towards these other, sometimes larger loans. It can come down to a personal preference if the interest rates are close to the same.

Quick Summary

Federal loans are much better than private loans because they offer payment flexibility and forgiveness programs. Say goodbye to Perkins loans, they are leaving us next year. Fill out the FAFSA as early as you can to get a clear picture of how much you’ll need to borrow. Be smart about how you pay back your loans.