How Do Student Loans Work?

Most good-paying jobs require you to have studied the right major in the right field. That’s why you decided to go to college. Unfortunately, education is not cheap, and it’s really a shame considering so many young people need a college degree to obtain gainful employment. 

When you are lacking the funding  to pay for college, student loans are often the only alternative. They give you the opportunity to have the educational experience you so often hear about. It’s important however to understand how student loans work before you go drowning yourself in debt. There is no use in selecting a major that will not generate the annual salary upon graduation that will allow you to repay your student loans. Before getting yourself into debt, let’s gain an understanding about the way these loans work.

What Are Student Loans?

Student loans are simply a way of funding your education. Basically, you borrow a sum of money from the government, a bank, or some other lender and then you have to repay it back over time. Student loans must be used for the express purpose of covering educational expenses such as tuition, room and board, books, or anything else that helps you to further your educational endeavor. Eventually you must repay the principal and the interest which accumulates over time based on the interest rate that the lender charges .

How Do They Work?

Student loans differ in comparison to other types of loans. Unlike other forms of financing, some student loans have an easier approval process. The loan requirements of having work history, current employment, and income are often more lax for dependent students because student loan payments are often deferred until after graduation. Most dependent students either do not have a job, are employed in lower level jobs earning minimum wage or are surviving with the help of their parents. Therefore, they don’t need an incredibly high credit score to be approved for a loan. The interest rates on student loans are generally much lower than those for personal loans, automobile loans, and secured loans making them a better financial deal for the student loan borrower. 

Student loans typically give you a minimum of 10 years to repay the loan. Some student loans will stretch out for almost as long as a mortgage allowing you to repay over a 30 year time period. Student loans typically have a monthly payment requirement with some being as low as $50 while other loans may cost $1000 a month or more depending upon the total amount of money borrowed. For example, a student who attends Harvard University and finances their entire education with loans would graduate with a whopping $280,000 in student loan debt whereas a student attending a local state college could graduate with roughly $20,000 in debt. The amount borrowed makes a major difference in the monthly repayment amount and the time that it will take to repay the debt.

The good thing about student loans is that you can get a loan that is income contingent, income sensitive, or income based meaning monthly loan repayments adjust based on the borrower’s income and other outstanding debt obligations.

What Are the Types of Student Loans Available?

There are two major types of student loans available for you, and these are:

Private Loans

Private loans are those that come from private lenders such as a bank, non-bank financial institution, a credit union, or a state loan agency. Lenders such as Discover, Sallie Mae, and Citizens Bank offer private loans. Private loans typically have more requirements and may require the student to have a creditworthy cosigner before taking the loan out. Private loan applicants must meet age, education, citizenship, income, and credit score requirements. In addition, the interest rate on private loans can be either variable or fixed meaning that when interest rates rise; you will pay more for your education.

Federal Loans

Federal loans represent the most convenient option of the two, primarily because they have a larger list of benefits compared to private ones. Student loans are loans issued by the federal government. They are fixed rate loans meaning that your payment will never rise and the best thing about them is the fixed interest rate fixed. The current average interest rate on a federal student loan is 5.05%. whereas private lender rates can easily hit the high teens. Some private loan borrowers are paying 18 and 19 percent interest on their loans. Federal loans also have the deferred repayment option meaning you don’t have to worry about repaying it too soon. The repayment plan will start once you have completed your schooling. 

Direct Subsidized and Direct Unsubsidized Limits

Independent undergraduate students can borrow anywhere from $9,500 the first year to $10,500 the second year to $12,500 per year for the third and fourth years for educational needs. (Independent students are those who meet one of the following classifications: 24 or older, married, emancipated minor, in the military, grad student, claims other dependents, homeless). The total limit over a lifetime for independent undergraduate students is $57,500. Dependent undergraduate students can borrow anywhere from $5,500 the first year to $6,500 the second year to $7,500 for the third and fourth years for their education. The total limit for dependent undergraduate students to borrow is $23,000. 

Federal student loan debt doesn’t necessarily have to be repaid either. Federal student loans are forgiven by the government if you work for a nonprofit or other acceptable organization for at least 10 years, or make 10 straight years of payments on-time and fill out paperwork requesting debt forgiveness.

DirectPLUS Loans

Direct PLUS loans are the federal loans available to cover all of the educational needs that direct subsidized and direct unsubsidized loans do not cover. Direct PLUS loans are often referred to as Parent Plus Loans because the loan is made to the parent of a dependent student. It is important to consider the advantages and disadvantages of Direct PLUS loans before applying for one.

Eligibility

You must be the biological or adoptive parent of a dependent student who is enrolled in school for at least half time. You must not have an adverse credit history. You must meet the general eligibility requirements for financial aid. You can find more information regarding eligibility here

Advantages and Disadvantages

The good news is that Direct PLUS loans allow you to borrow the total cost of education. They will cover books, tuition, room and board, any educational expenses.  There are no loan amount limits. It will cover the whole cost of the education. Direct PLUS loans allow you to request a deferment and defer making payments on the loan until your child finishes school. You can apply directly for the loan on the studentloans.gov site. There are several repayment options allowing you to repay the loan over 10 to 25 years based on your selection of the standard, graduated, or extended repayment plan. The standard plan has the same fixed payment for 10 straight years. The graduated plan has payments that start lower and increase over time. The extended plan gives lower fixed payments but for a longer period of time (25 years). The extended plan costs you the most in interest payment over time.

The bad news is that Direct PLUS loans have a higher interest rate than a regular student federal loan. The current interest rate is 7.6%, which is higher than the subsidized and unsubsidized federal loan rates. 

How Much Can You Borrow?

It’s important to remember to only borrow the amount you truly need. You have to take into consideration that student loan debt is not free money. You will have to pay back the sum that you borrow plus interest. Make sure the amount you borrow only covers the absolute necessities. 

Final Thoughts

Student loans are a necessary evil. They can be an amazing financial tool, if you find yourself needing money to finance your educational needs. 

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