By early 2019, Americans owed nearly $1.5 trillion in student loan debt. And with research showing that young people are more likely to take out student loans to finance their education than ever, it’s essential to understand the student loan landscape.
Before you dive into applying for student loans, take the time to educate yourself on the different types of student loans, how to apply for them and what to keep in mind before and after you’ve taken them out.
A student loan is borrowed financial assistance that covers the cost of an education at a college or university (for things like tuition, books, housing, a meal plan, and technology). It is ultimately repaid plus interest that accrues each month. There are two categories of student loans:
Private loans are distributed by a bank, credit union, or state-based organization. The conditions are determined by the lender, interest rates are often higher and variable (though some private loans have fixed rates), and they generally have less benefits than federal loans.
The following loans are available under the U.S. Department of Education’s federal student loan program:
These loans are need-based (meaning you must show financial need to be considered for them), also have a fixed interest rate of 4.53 percent and are only available for undergraduates. Because the Department of Education will pay the interest on them while you’re enrolled in school at least part-time, for six months after you graduate (called the grace period), and during deferment (if you postpone payments), they’re an extremely popular student loan. One thing to note: There is a loan limit depending on your year in school and dependency status (ranging from $5,500 to $12,500 per year).
These government loans are not based on financial need and currently have a fixed interest rate of 4.53 percent for undergraduates and 6.08 percent for graduate and professional students. The school you’re attending determines the amount you can borrow (based on your other financial aid and cost of attendance) and you are responsible for paying interest on the loan during the duration of your loan period—even when you’re in school. If for some reason you don’t pay the interest, it will be added to the total cost (or principal) of the loan.
Unlike Direct Subsidized Loans, the interest will still accrue during a deferment period. Additionally, there is a loan limit depending on your year in school and dependency status (ranging from $5,500 to $12,500 per year for undergrads and up to $20,500 for graduate students).
For graduate and professional students and for parents with dependent children, Direct PLUS Loans are credit-based and they cover the total cost of attendance minus any other financial aid. The interest rate is fixed for the life of the loan and currently at 7.08 percent.
You can apply for a Direct Consolidation Loan to combine all of your monthly loan payments into a single payment and one interest rate. There are pros and cons to consolidating your loans, like lowering your monthly payment and access to loan forgiveness programs, but also a potentially longer payoff time.
There are some requirements for being eligible to apply for a federal student loan, like being a U.S. citizen or permanent resident and enrolled at least part-time at a school that participates in the federal loan program. To determine what kind of federal student loans you qualify for, each year that you’re enrolled in school you must first fill out a Free Application for Federal Student Aid form (known as the FAFSA form). Once processed, you’ll receive a financial aid offer from your school that may include federal loans, work study, and grants. There are different federal and state deadlines for the FAFSA application. Contact your school’s financial aid office as well to ensure that you’re aware of any internal deadlines and processes.
After you receive a loan offer from your school and want to move forward, you are required to attend in-person or online counseling (called entrance counseling) that reviews the responsibilities of taking out a loan. Then you sign a Master Promissory Note (or MPN), which is a contract to agree to the terms of your loan and promise to repay it plus interest. Be sure to read the entire Master Promissory Note so that you understand how your loan works and what your repayment options will be.
Finally, your loan will be distributed by your school and used to cover any tuition, fees, housing costs, or other charges. The remainder will be disbursed to you to use on any other education-related expenses.
Paying back student loans can be daunting, especially if you aren’t aware of all of your options. There are a multitude of repayment plans for federal loans that take into account factors like income and family size, and grant you more time to pay them off. For example, loan payments under the Revised Pay As You Earn Plan (REPAYE) and Income-Based Repayment Plan (IBR) are generally 10 to 15 percent of your discretionary income (income remaining after taxes are deducted and necessary expenses are paid) under a 20- to 25-year repayment period. Your spouse’s student loan debt is also considered if you file taxes jointly, and payments are recalculated each year. If you remain on some of these plans for the entire period and haven't yet paid off all of your loans, your loans can even be forgiven.
During your six-month grace period on your student loans, you can get ahead by contacting the Federal Student Aid office to discuss your eligibility for various repayment plans, update any contact info and organize paperwork; and if you are able, start making payments on your loan—which could save you money overall.
The Federal Student Aid office recommends applying for federal loans before considering private loans. Because of factors like higher and variable interest rates (as of 2019, private loan interest rates are reported to be as high as 14.24 percent) and fewer protections and repayment options, they’re considered one of the riskiest ways to pay for college.
But for many students and families that don’t qualify for enough (or any) federal student aid, private student loans may fill funding gaps or be the only other option to financing an education. About 1.1 million undergraduates received private loans in 2015 to 2016, according to a report released this year by the Institute for College Access and Success.
There are many lenders to choose from (a few are SoFi, Sallie Mae, and Citizens Bank) that offer various loans with different payment terms, rate types, fees, and application requirements, so you’ll first want to do some research on loan providers to decide which lender offers the right loan for you and that your school will accept. You should refer to your FAFSA application results to figure out what you’ll need to borrow, or look at your school’s financial aid website for estimated costs.
Because the application process and distribution for a private loan can take several weeks or longer, you’ll want to give yourself ample time before tuition or other costs are due. You can visit lender websites to determine your loan eligibility first, and if it’s a good fit, most providers allow you to submit an application online with required personal, school, and financial information.
If you’re approved for a private loan, sign any necessary paperwork, and accept it. Then the loan will be sent to your school to approve, and used to cover any tuition, fees, housing costs, or other charges. Like federal student loans, any remainder will be disbursed to you to use on other education-related expenses.
If you’re considering applying for a private student loan, here are some other factors to take into consideration:
Private loans require a cosigner or a credit check, which determines the interest rate. If you don’t have credit history or cannot secure a cosigner with good credit, you may still qualify for a private loan, but with a higher interest rate.
Some private lenders allow you to defer loan payments while in school, but depending on your lender you may be required to make payments while you’re still enrolled.
Often, private loans aren’t subisidized, so you may be responsible for all of the loan’s interest.
You cannot consolidate private loans, but depending on your lender, you may be able to refinance them at a lower interest rate.
Private loan lenders tend to be less forgiving with repayment options than the government is with federal loans. Federal loans come with options like forbearance (where you temporarily stop making payments but are responsible for paying interest) and deferment (where you temporarily stop making payments and may not be responsible for paying interest). Those options are not offered by every private loan lender.
Some private loans tack on loan fees that end up increasing the overall cost of your loan.
The interest you pay each year on the loan may or may not be tax-deductible.
Not every private lender is the same. For example, some private lenders require you to make loan payments while you’re still in school, while other lenders may offer grace periods and flexible repayment plans or deferment and forbearance. If the interest rate on your private loan is variable, and it goes up over time, you may be able to refinance your loan to get a lower interest rate if you can’t afford the payments. But private lenders are not required to offer borrowers those options. The National Consumer Law Center’s Student Loan Borrower Assistance Project says some private lenders may actually charge for these services, and borrowers should review their loan contract to understand their rights.
Some private lenders may also offer short-term repayment relief such as interest-only repayment plans or reductions in interest if you’re consistently paying on time or elect for automatic debit payments (but there’s skepticism around these offerings). There is generally no loan forgiveness with private loans, although loans from state agencies may be forgiven in certain situations, and private loans are quite difficult to discharge in bankruptcy.
Important to consider is that you accrue interest on your loan as soon as you take it out, so look at shorter and longer repayment terms to see how you can save. If you pay off your loan in the course of 10 years versus 20 years, for example, you’ll pay less in interest but your payments might be higher.
Ultimately, if you end up taking out a private loan, the right move is to be in communication from the get-go with your lender and read a copy of your loan contract so you’re informed about repayment.
Even if you miss one loan payment, your loan becomes what’s called delinquent and could go into default. But there are more options of getting out of default with federal loans than with private ones.
For example, a federal loan isn’t considered in default until it goes unpaid for 270 days (after 90 days all three national credit bureaus are notified) while some private loan lenders consider a loan to be in default after just one missed payment or may allow several months of delinquency before a loan goes into default. If any type of loan goes into default, the entire balance of the loan becomes due immediately and it could negatively impact the borrower’s or cosigner’s credit.
Look into all of your options before accepting any loan and make sure you read and understand all of the terms of your loan. You’ll also want to keep track of important documents, and only borrow what you need (you can request less than what you’re offered and return any loan money that you don’t use).
After graduation, keep in touch with your loan servicer and if you end up on a yearly income-based repayment plan keep track of deadlines for when you need to recertify. The key is being proactive and responsible with your student loans.
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