Student loans can seem scary, complicated, intimidating, and difficult to understand, and to an extent- they are. Let’s work together to clear up some common vocabulary, types of loans, different payment options, and the steps you will go through before making the decision to sign the dotted line!
Written by Josephine Redfern
College is expensive and paying for it can seem impossible. However, there are ways to pay for college, such as using loans provided by private banks and/or the government. In fact, student loans can be a great option, especially if you have limited savings or haven’t received any scholarships – although these areas should all be explored first before considering obtaining a student loan. Most of what it takes to understand student loans is an understanding of the vocabulary that goes along with them! Let’s start there.
A loan is an amount of money given to you with the expectation that it will be paid back in full, plus interest accrued on the loan, at an agreed time in the future.
Interest is the percentage of a loan that is added to the original balance or the principle of the loan. When you pay back your student loan, you will be paying back the original amount of the loan, plus the interest. For example, if you take out a 5-year loan for 100 dollars with a 5% annual interest rate, at the end of the 5 years you would owe $125. This is because 5% of the original $100 is $5. $5 multiplied by 5 years is $25 and $25 plus $100 is $125! That would be an example of simple interest, which like the name suggests, is a little simpler to understand.
On the other hand, we have the more commonly used compound interest. Compound interest is based on the overall balance of the loan, including the original amount and the unpaid interest that is adding up or accruing over time. Compound interest essentially means that the loan is charging interest on interest. If the interest isn’t paid as it accrues it is capitalized or added to the balance of the loan. For instance, if you have a loan of $100 that is charging 5% interest every year, the interest at the end of one year is capitalized so the new loan balance would become $105. The interest in year two would be $5.25 (5% of $105 and so on for the length of loan). Remember you would still be paying interest on top of this capitalized amount, which can significantly increase the longer it takes you to pay off your loan.
Types of Loans
Now that we’ve covered the vocabulary part of student loans, let’s look at the different types of loans that you could apply for as a student!
First, there are public loans. Every student who wants to attend college can file for FAFSA (Free Application for Federal Student Aid) and will be eligible for federal loans and grants based on their FAFSA application. Federal loans have a fixed interest rate, meaning that the interest rate cannot increase over time. When you are looking at the different types of student loans, pay attention to the rules and stipulations that are attached. Some loans cannot be used for certain graduate programs, fields of study, or to cover certain costs associated with higher education. Check out this great article from BALANCE to learn about some things you can do before filling out FAFSA. If you fill out FAFSA and don’t qualify for government loans, you can consider looking for more scholarship options. Here is our blog on scholarships that can help you learn more about where to look!
Second are private loans. Private loans are offered by private financial institutions and typically have more fees attached to them, increasing the principle balance of the loan. These loans are going to have different interest rates depending on how good the applicant or cosigner’s credit score is, and other deciding factors such as market factors, income, and employment history. Here’s an article from BALANCE that can help you understand your personal credit score and the factors that may affect it.
The next type of loans are considered to be subsets of public and private loans. The first of these are subsidized loans. A subsidized loan doesn’t accrue interest while the recipient is in school. The federal government pays the interest during the student’s undergraduate degree and during a 6-month grace period post-graduation. The loan begins accruing interest after the grace period and at that point the recipient must start paying back the loan and the interest it has started to accrue. These loans are generally meant for students who need more financial assistance. The opposite is an unsubsidized loan. These begin accruing interest immediately. Interest that accrues before the grace period or any type of deferment is compounded and capitalized upon. Private loans are always going to be unsubsidized.
Now that you have a basic overview of loans and how they work, let’s talk payment options!
First, we’ll discuss times that you don’t pay. When you are using a subsidized loan, your loan is in a state of deferment. Deferment essentially means that you aren’t required to make payments towards your loan, and no interest is accruing. You can also go into deferment at other times, but you must meet specific criteria set by your loan provider. If you meet the requirements, you cannot be turned down. For example, because of COVID-19 all federal student loans have entered a state of deferment! You can also enter deferment if you are undergoing cancer treatment, receiving welfare, or have entered a graduate fellowship program. Once the deferment period is over you are responsible to start paying the loan back again at the amount previously owed. For most loans, after the deferment period is over, you won’t be required to pay back interest that compounded during deferment.
Similar to deferment is forbearance. Forbearance also needs to be approved and granted to you by your loan servicing provider, but the requirements are not as specific. When your loans are in forbearance, you don’t have to pay the loan, but the interest is still compounding. After the forbearance period has ended, you would be responsible to pay back the loan and any of the interest that has capitalized.
Federal loans also typically have a grace period of 6 months post-graduation, or after someone leaves their education. This is the period where payments do not need to be made on a loan. Depending on your job, or whether you are continuing your education, a grace period may be extended.
Finally, we will discuss the inevitable time that will come when you do need to pay back your loans. When you are in school, be sure to visit your school’s financial aid office to see if there is any other way for you to minimize your debt, or get a sense of what your payments will be after graduation. When paying back your student loans, it’s important to keep a budget and be in touch with your loan servicer so you can keep track of exactly how much you will owe on your loans every month. Paying in a timely manner is super important as well, because if you are late on payments it could negatively affect your credit score. You will be able to choose from different payment options based on your income and budget. For instance, there are interest only payments, graduated payment plans, or even loan consolidation options. You should communicate with your loan servicer often so that you can understand your specific financial situation, your loans, and how they will work together. Also, there are certain circumstances where the government will forgive some or all of a federal student loan. You could be eligible for loan forgiveness through military service, approved volunteer work, teaching or practicing medicine in certain communities, and work in the public sectors. All these options can help you to pay off your loans in a timelier manner, to eliminate some of the stress they bring.
Looking at the big picture of student loans, it can be scary. But by breaking it down into smaller pieces, they can become more understandable and easily managed!