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Student Loans 101: The Fundamentals of Student Loans

Joan PabonMar 29, 2018

I was seven years old when my mother finally paid off her student loan. I remember this because she had to sell our car to do so and, for the next couple of years, we were forced to take the bus, hitchhike, or borrow grandma's old beater to get around. Knowing my mother's struggles, I always told myself that when it was my turn to go to college, I would avoid student loans altogether and pay for everything myself. I planned to work hard, save up, and cover most of my education expenses out of pocket and with the help of any scholarships or grants I could qualify for. Little did I know my fate had already been decided for me, like that of most young Americans.

"Education is the most powerful weapon which you can use to change the world."
-Nelson Mandela

If you've graduated high school and are now looking to go to college, odds are you already know the value of a good education. Indeed, education is the greatest tool at our disposal to make the world a better place. That's because learning changes us for the better. It opens our minds to previously ignored possibilities and new points of view; it transports us to uncharted worlds where the promise of a brighter future is on the horizon, urging us to keep moving forward. All those years spent in school were merely the beginning of a long journey, a preparation for the true test of strength: college. Once you've overcome the first hurdle of getting accepted into an accredited school, you'll then be faced with the challenge of obtaining sufficient funding to cover the endeavor, or at least the first couple of semesters. According to statistical data published by the The College Board, the cost of higher education for one academic year in the United States has risen with inflation, bringing undergraduate costs in a four-year public university to an average of $18,390 with fees, room and board, while the same number of years in a private university could cost around $44,820. While applying for scholarships and grants could help you shoulder a portion of those expenses, a good majority of students still find it hard to get by unless they can obtain other sources of income.

Scholarships & Grants

If, like me, you only got decent grades but never the highest in your class, you weren't terrible at sports, but neither were you exceptionally good at any given one, and your musical, artistic, or literary abilities were overshadowed by other, more dedicated overachievers, then you may be among those of us who didn't get a full academic merit or athletic scholarship. If that's your case, don't feel discouraged, because there are numerous scholarships available from different sources, especially for those that belong to underrepresented groups, come from limited-income backgrounds, and have good writing skills. Inform yourself and keep trying. High-school students aren't the only ones eligible; you can be enrolled in college and still qualify for a host of scholarship opportunities you may never have heard of. Government aid is also available for all qualifying students, so make sure you fill out the Free Application for Federal Student Aid (FAFSA) to see if you are eligible for financial assistance. Also, drop by your institution's financial aid office and speak to an officer who can provide you with a list of scholarships and loan programs available through your school.

In the event you don't get a scholarship—or you do but it doesn't cover all your tuition, housing, or personal expenses—getting a part-time job, perhaps through a work-study program or a paid internship, could be the difference between eating real meals every day and having to eat ramen for breakfast, lunch, and dinner. That's an exaggeration, of course, but having some income will afford you greater freedom and give you a sense of empowerment you won't get while being dependent on your family. If, after trying everything, you still can't afford your education and are considering a student loan; you're not alone. In fact, you are about to become one of approximately 44 million people in the U.S. living with student loan debt. Until we find a way to change it, that's how the system is rigged, but we can still exercise agency by planning and making informed decisions. Taking out a student loan isn't as terrible as it's made out to be; however, just know that unless you have a repayment plan in mind and make smart financial decisions, you'll likely be stuck making loan repayments for a long, long time.

Types of Student Loans

First, let's go over the basics of student loans, how they work, and how to apply for one, and then we'll discuss the most important part: how to pay them off. If you need to brush up on financial jargon, check out our glossary of student loan terminology.

There are two main types of student loans, federal and private, and these can be used for a variety of different educational purposes, from covering the cost of private education for children in grades K through 12 to the ones we'll be focusing on, which cover undergraduate and graduate tuition costs. Federal student loans can be either subsidized, meaning you don't have to pay interests on them while in school, and unsubsidized, for which you have to pay interests while in school or else they will capitalize or get added to the principal loan amount. Let's go over each of these in a little more detail:

Subsidized Federal Student Loans — These loans, also called Direct Subsidized Loans or Stafford Loans, typically offer lower interest rates and more flexible repayment terms for undergraduate students with financial need. With these loans, you don't have to pay interests while in school because the U.S. Department of Education covers those costs while you study at least part-time and for the first six months after you graduate, also known as the grace period. The drawback with this option is that not everyone will be eligible and students who are may only borrow the amount the school determines they can receive. However, repayment terms also include a deferment or loan payment postponement option, which gives greater flexibility come repayment time.

Unsubsidized Federal Student Loans — On the other hand, Direct Unsubsidized Federal Student Loans are available for both undergraduate and graduate students, regardless of financial need. The school still determines how much you can borrow based on your tuition expenses and any other financial aid you receive, and you're responsible for covering interest payments while studying. However, you also have the option of letting interest accrue and eventually capitalize, which means interests will accumulate and later become part of the principal loan amount or the sum you originally borrowed.

If you don't qualify for a federal student loan, you may still qualify for a private student loan. These types of loans don't often feature such flexible repayment terms but are a suitable last resort for those who have already exceeded the borrowing limit with federal loans or, again, don't qualify for any other option. Private loans may also set higher qualification requirements for borrowers, meaning you will have to show proof of income and good credit to be deemed eligible. If you don't meet either of these criteria, you may apply with a cosigner, which may be any U.S. citizen or legal resident over the age of 18 with sufficient income, a good or excellent credit score, and no prior history of defaulting or failing to pay back their loans. Your cosigner's credit score will be one of the factors that determine your interest rate, so the better his or her credit score is, the lower your interest rate will be.

Photo: John Schnobrich on Unsplash

Loan Details

Regardless of the type of student loan you opt for, it will be of the utmost importance that you read every term and condition in your loan agreement with a loan officer or someone well-versed in student loan terminology. When I signed my loan agreement, I didn't even look at the interest rate, which determines how much you'll ultimately pay for borrowing money from a lender. If, like mine, your student loan is sold to a different student loan servicer, you'll have to make your loan repayments through this new company, making it all the harder to figure out how much interest has accrued on your loan. So before signing anything, figure out the details of your loan.

Principal Amount — The principal loan amount refers to the total sum you borrow plus any interest that has capitalized.

Loan Term — The term of your loan is the timeframe in which you'll be expected to pay off your loan in full. Most student loans have a term of ten years, though shorter or longer terms may also be available. The term of the loan will also depend on the loan balance; a smaller loan amount could mean a shorter term, while a larger loan amount could mean an extended loan term.

Interest Rate — The interest rate is a percentage of the principal loan amount charged by a lender to a borrower for the use of its funds. It is often also expressed as an annual percentage rate (APR), which includes all additional fees and costs. Interest rates for federal student loans are always fixed, meaning they remain the same throughout the life of the loan. Privates student loans may have either fixed or variable interest rates, which can increase or decrease according to market fluctuations. While federal student loan rates are generally favorable, private student loan rates depend on the applicant's credit history and income or those of his cosigner.

Fees — Some student loan lenders, particularly private ones, apply additional charges, called fees, associated with the loan application and origination process. Fees for late payments may also apply.

Discounts — Some private lenders offer discounts on their loans in an effort to be more competitive. There are several different types of discounts available, which will depend on the lender and its borrower qualifications, yet common options include discounts for setting up direct debit payments, on-time payment discounts, and a waived origination fee discount.

Repayment Options

Federal student loans allow borrowers to defer student loan repayments while they are active students with at least a half-time status. These may also include a grace period of six to nine month after graduation during which student borrowers are also exempt from having to make loan repayments. However, some federal student loans, like PLUS loans, don't offer a grace period and require borrowers to begin making payments as soon as the funds are disbursed. Standard federal loan terms extend for ten years, yet borrowers may be eligible to extend the term of the loan for up to 25 years. Most federal loans are also eligible for the following benefits:

Deferment — This is a repayment option that allows you to temporarily suspend loan payments or reduce loan repayments for a specified period until you can afford to do so. Although this option is mostly available through federal student loans, some private lenders may also offer it.

Forbearance — This term is often confused with deferment, yet differs from the above in that interests on the loan continue to accrue during the time loan repayments are suspended or reduced. Forbearance is available for those who borrow federal loans, yet some private student lenders also extend this option.

Forgiveness — Federal student loan forgiveness may be granted in certain special cases, such as when students offer their services to the government by becoming teachers or working for non-profit organizations. Other grounds for forgiveness include becoming totally and permanently disabled or—though it may sound grim—dying.

Income-based repayment — This repayment option allows students to make affordable loan repayments that are based on their income and family size.

Consolidation — Consolidation essentially entails taking out a new loan to pay off all your existing loans. You can, for example, roll all your federal student loans into a Direct Consolidation Loan or consolidate all your private student loans through a private lender. Although some private lenders offer to consolidate private and federal student loans together, consolidating federal loans through a private lender could entail losing the flexible repayment options characteristic of federal student loans. The general benefits of consolidation, however, include simplifying payments—so you only have to pay a single lender—having the option of choosing a fixed interest rate over a variable one (for private student loans), and being able to select a longer repayment period to lower your monthly payment amounts.

Refinance — Refinancing works much the same way as consolidation, where you take out a new loan to pay off an existing one, this time with the goal of obtaining a lower interest rate or switching from a variable to a fixed rate. Like consolidation, however, refinancing a federal loan into a private loan would mean losing the repayment and forgiveness benefits offered by federal loans.

Since private student loans are offered through various private entities and financial institutions, repayment terms will vary from lender to lender. While these types of loans don't often feature deferment, some lenders may still offer that possibility. Private loans can have slightly more stringent repayment terms, but may offer the following repayment plans:

Deferred Repayment — While the borrower is a half-time or full-time student, he or she will not be required to make any payments on their loan. Payments will be due once the borrower graduates or drops below half-time. With private student loans, interest is still accrued during this period, and students may make payments toward the interest to keep them from being capitalized once they graduate. Many private student loans do not offer this option, but some do.

Fixed Repayment — Fixed repayments are low monthly payments made while the borrower is still an active student. These can be as low as $25 a month while the student is active and under a full- or half-time status. Once the borrower graduates or drops below half-time status, then they are responsible for making payments toward the principal and accrued interest.

Immediate Repayment — Immediate payments are scheduled to begin as soon as the loan is disbursed.

Interest-Only Repayment — This repayment option requires the borrower to pay toward the interest while they are an active student. Once the student graduates or drops below half-time status, they will make payments toward both the interest and the principal amount.

Photo: Tim Gouw on Unsplash

How to Pay Off Your Student Loan

Student loans can be your golden ticket to a higher education, a life-changing experience that shouldn't come with such a hefty price tag. Alas, sometimes we have to take the bad with the good and make the best out of a tough situation, so we take the loan and deal with the consequences later. The problem is that later comes much sooner than we expect, and sometimes we're not prepared to pay our dues when lenders and creditors come knocking. If you're considering a student loan or already have one and feel you're in over your head with your student loan repayments, sit down with pen and paper and start getting organized.

Start paying down interests while you're in school. Whatever extra cash you make should go toward your student loan. Lenders make money by charging you for borrowing, meaning the longer you stay in debt, the more they'll charge you in the form of interest. Your initial loan repayments will go toward the interest on your loan, which will continue to accrue as long as some portion of the principal loan balance is outstanding. A lot of people feel frustrated when they start making timely loan repayments, and their debt still doesn't seem to go down, and that's the reason behind it. You pay on time each month, but you pay the minimum, which gets applied to the interest, which continues to accrue! It's a vicious cycle that can only be broken by tackling the interests as soon as possible and with force.

Create a debt management plan by making a list of all your student loan debt, including interests and penalties, and follow by adding all of your existing debt from other sources, be it credit cards, auto loan repayments, etc. After writing down all of your existing debt, organize them from smallest to largest. Financial author and radio personality Dave Ramsey suggests clearing the smallest, most manageable debts before tackling bigger bosses like student loans to get out of debt faster. He calls it the debt snowball method, and it entails making minimum payments on all your current debt except the smallest one, for which you'll pay as much as possible. You'll continue doing this until the debt is paid in full and you can move on to the second largest on the list.

  1. Create a monthly budget that takes into account your income and all your financial responsibilities. Knowing exactly what your money goes toward each month can help you cut unnecessary expenses and keep you focused on the goal at hand: becoming solvent. The hardest part will come after creating the budget, and that is sticking to it and not going over your maximum estimated expenses for each month.
  2. Pay more than the minimum when you're able to. If you get a tax return, Christmas bonus, or an inheritance from a long-lost relative, use that money to make larger student loan repayments. By paying more than the minimum, you'll keep interests low and be closer to paying off your loan than you would be if you paid the minimum and dragged the loan term out for longer.
  3. Pay what you can with cash and avoid taking out any more loans. If you don't want to be paying your student loans by the time you have three kids and a mortgage, stop taking out loans, try to pay with cash as much as possible, and prepare to make sacrifices for the sake of a simpler future.
  4. Consider consolidating your loans or refinancing to a lower rate, but inform yourself about any benefits you might lose by doing so. These options may not be the best for everyone, especially those who only have one or two loans with favorable rates and terms and those with federal student loans.
  5. Consider bankruptcy, but only if you're at the end of your rope. If careful financial planning can't seem to get you ahead and you feel like you're drowning in debt, remember that your health and well-being are more important and valuable to your loved ones than a good credit score. Bankruptcy entails damaging your credit for a period of seven to ten years, which is how long a bankruptcy can show up on your credit report. That isn't necessarily a bad thing; it just means it will be much harder to borrow money or get approved for a credit card during that time.

If you run a quick online search, you'll find countless threads and forums where people discuss the best and fastest ways to get out of debt and pay off their student loans. You're not alone; there are many of us dealing with the same issue. Although there is no quick and easy solution to getting out of student debt—unless you opt for a profession that makes you eligible for student loan forgiveness—whatever debt management strategy you choose will entail having to cut back on expenses like concerts and vacations until you're able to pay down or settle what you owe. Sticking to a budget and making conscientious financial decisions can be harder than getting into college, but this will be the surest way to becoming debt-free. Don't lose hope; it's completely doable. You just have to tighten your belt for a little while and focus on the good times ahead. Soon you'll be planning backpacking adventures through Europe, and even crazier shenanigans, like postgraduate studies.