A Primer on Student Loans: 5 Q&As to Help
By Assunta (Susie) McLane, Summit Place Financial Advisors, LLC –
September 1, 2021
Whether you are a senior graduating high school or a senior graduating college, the process of applying for a student loan or getting ready to pay for a student loan may come with some complexities.
The following are five questions that students and their parents/guardians often ask relating to student loans:
1. What do all of the different terms mean?
Understanding some of the basic terms and vocabulary can help when it comes time to applying for and repaying your loans.
- Principal — This is the base amount you owe on the loan; this amount does not take into account interest. If you took out a loan for $40,000, your principal balance would be $40,000. As you repay your loan, your principal balance declines.
- Interest rate — The rate is how much interest you will be paying on the loan. The rate tends to be fixed, meaning it stays the same over the life of the loan.
- Term — The stated amount of time you are expected to repay the loan is your term. Repayment terms typically range from five to 15 years. Making your payment on time is crucial to avoiding additional fees, interest charges and penalties. If you are ever thinking of paying your loan off earlier than the term, you will want to ask if there are any prepayment penalties.
Your monthly student loan payment is calculated based on a combination of the principal balance, the fixed interest rate and the loan repayment term.
- Grace period — This is the amount of time you have after graduation before you need to start paying back your loans. This will differ depending on the type of loan you have. For example, Stafford loans allow for a six-month grace period where Perkin loans offer a nine-month grace period.
2. What is the difference between federal and private loans?
Federal loans are provided by the government and the interest rate is set by Congress. There are several types of federal loans available and yours may be subsidized or unsubsidized; a Perkins loan; or a PLUS loan. Most federal loans do not require a co-signer, meaning the student is fully responsible for repaying the loan.
You may apply for a federal loan by completing the Free Application for Federal Student Aid (FAFSA). Once a FAFSA form has been completed, the school’s financial aid office will figure out how much aid you qualify for and will provide the details of your financial aid offer, typically made up of scholarships, grants, work-study and loans.
When it comes time to repay your federal loans, you may have the option to tie payments to your income upon graduation. Any repayment options will need to be discussed with the loan provider.
Private loans are offered by banks and other financial institutions. These types of loans may require a co-signer because they will want to see proof that someone can repay the loans and that the loan will be backed by good credit. There are several different private loans available depending on your specific circumstances.
Most private loans require payments to begin upon graduation. The payment terms are set when the loans are first established. Repayment options or deferring payments should be discussed with the loan provider.
3. What repayment options do I have?
With federal loans, the standard repayment term is 15 years, and you may have alternative repayment options to consider too. It is important to note that while other repayment options are available, the longer you defer paying your loans, the more interest you will be paying in the long run.
In some cases, if you qualify based on financial need, the government may pay the interest on your loan while you are in school. This type of federal loan is referred to as a subsidized loan. An unsubsidized loan is where you are responsible for paying all the interest on your loan.
There are several repayment options for federal loans. Some options will allow you to stretch those payments over a longer period and others may allow you to adjust your payments based on income.
Here is a link to help understand some of those repayment options: studentaid.gov/manage-loans/repayment/plans
Private loans do not come with many repayment options. The repayment terms typically range from five to 15 years. Some private lenders may offer a discount if you set up autopayments monthly. Unlike subsidized federal loans, the private lenders will not cover your interest payments.
It is important to understand all your options before applying for a loan. The type of loan will determine if there’s any flexibility with repayment and how much you will have to pay upon graduation. Once you have graduated it is a good idea to review your budget and determine where you can trim expenses to help put more funds towards paying off your loans. Sacrificing a bit in the short term may mean paying off your loans quicker.
4. How do I prioritize paying back my loans?
One of the best approaches to paying off your student loans is to pay more than just the minimum each month and make extra payments when you can. It may not always be easy to put such a large portion of your take-home pay towards your student loans, so you can consider a few other options.
If you have multiple loans, you typically want to pay the loan with the highest interest rate first. You also want to make sure that you are paying the minimum balance on your other loans. If you get a raise or a bonus, consider using some of the funds to put towards the highest-rate loan.
There are instances when you can defer your payments with federal student loans. This allows you to temporarily stop making payments for a certain period. It is important to note that interest due during this period will be added to the principal of the loan. While this may seem like a great idea, it will cause your balance to continue growing and will be more expensive in the long run.
We all know life happens, but to the extent possible, you would be best advised to avoid deferring payments and always make minimum payments towards your loan. Even paying the smallest amount will help chip away at the balance.
5. Should I consider refinancing?
If you’re a few years out of college, working your first full-time job and you’re reviewing your budget, you may be thinking, “How can I pay off my student debt quicker?” Refinancing may be a good option, but it is important to understand a few things before committing to a refinance agreement.
When you refinance, you are looking to find options to help pay down your loans quicker. Refis often will consolidate all your outstanding loans and they should not cost you additional fees. You do not want to take on additional debt while trying to pay down old debt. The new loan should be at a fixed interest rate, and it should be a lower rate than any of your current loans. Beware: if you are thinking of consolidating your federal loans, refinancing will disqualify you from any federal repayment options.
When refinancing, you want to either reduce your monthly payment or try to go with a shorter term so you can work towards paying off your loans sooner. Refinancing is not always the right option for everyone, and it is important to understand the new terms.
Student debt continues to impact so many college graduates. The amount of outstanding student loan balances in the U.S. continues to increase at an alarming rate. Managing your options such as applying for scholarships, work-study programs and grants will determine how much student debt you will need to take on. Then, understanding how to manage your loans upon graduation may make all the difference in the long run. Envision the goal of paying off your debt and make it your goal to stick to a plan that will get you there.
Assunta (Susie) McLane is a vice president and wealth advisor at Summit Place Financial Advisors, LLC. She can be reached at email@example.com.