There is a severe lack of financial literacy when it comes to how student loans work when paying for college.
Every college financial aid office says “Just apply for student loans”, but no one tells you how student loans work!
Tuition continues to rise, leaving millions of students burdened with large amounts of student loan debt. In fact, the average student is graduating with nearly $40,000 in student loan debt. That’s a little more than a Tesla Model 3 or even a wedding. Without student loans, many people wouldn’t even be able to attend college.
For most people going to college, student loans will become a fact of life. But where do student loans come from, how much can you borrow, and what is the real cost? In this article, you’ll learn all about how student loans work.
The ins and outs of student loans
Student loans are available to undergraduate and postgraduate students alike. They are based on need, of which income is only one component. Student loans are issued by the government (hence the term direct loan – directly from the government). However, private student loans are also available. The amount released to a student will depend on the financial situation of the student. The final decision is up to the school.
Financial aid packages are the first step in obtaining student loans. The financial aid package is composed of gift aid (such as grants and scholarships), loans, and work-study programs.
What is collateral for student loans? It’s important to remember that the collateral for student loans is your future earnings. When you buy a car and take a car loan, the collateral for the car loan is the car. So if you don’t pay the car note, the bank can repossess your car. In the case of student loans, it’s important to remember that the collateral is your future earnings. If you don’t repay student loans, the government can garnish your wages, take your tax returns, and more. Always keep this in mind while borrowing.
How to apply for student loan
FAFSAOr the Free Application for Federal Student Aid, which must be filled out each year to receive financial aid. FAFSA deadlines change every year. You can check the deadline here. Make sure your FAFSA is submitted on time. Otherwise, a late FAFSA will definitely complicate your financial situation and leave you struggling to pay for school.
To know how much financial aid you can be provided, check federal aid estimator Website.
When “awarded” with financial aid, you will receive funds for gift aid and loans. Your school’s costs should also be detailed. Schools display cost information in different ways and actual costs may be off by a large margin. Depending on what is shown, you may need to ask the school about costs:
- Tution
- Accommodation
- Eat
- Travel
- Fees (Laboratory, etc.)
- books
Add any other known costs. It is better to overestimate rather than underestimate. Many students find that they are still short on money even after receiving financial aid. This is due to many costs that are not accounted for.
Comment: The first year is also usually the least expensive year of college. The cost of your college will typically increase each year you attend college.
actually applying for student loans
Now that you have your financial aid award, you will see several “awards” of loans (note the parentheses – it’s horrible they call it awards). These loans are subject to the annual student loan limit, which is very low – only $5,500 in Year 1.
First, you will be offered a Direct Student Loan. it’s yours child’s loan. It may be subsidized or non-subsidized. With subsidized loans, the government pays your interest while you’re in school. With unsubsidized loans, your interest increases your loan balance while you are in school. That’s the only real difference. Read our full guide to subsidized vs. unsubsidized loans here.
Second, you may be offered a Parent PLUS Loan. these are loans parent loan. Your child has no legal responsibility for this loan. As a parent you can borrow for your child’s education. We hate parents having to borrow for their kids’ college, but we also know that some parents may not have planned for or wanted to have the difficult conversations. As a result, too much can be borrowed. Check out our complete guide to parent student loans here and make sure you understand the updated Parent PLUS borrowing limit of $20,000 per year and $65,000 total.
Finally, you can consider using a personal loan. Many families opt for a private loan instead of a Parent PLUS Loan. The private loan is taken out in your child’s name, but the parents are cosigners. This makes both of you responsible. For parents with great credit and income, private loans may offer lower interest rates. But they don’t come with any kind of loan forgiveness option, and rarely are the rates actually much better. Borrow at your own risk. You can check out our guide to the best personal loans here.
Make sure you compare Parent Plus vs. Private Student Loans – especially with all the changes going forward.
How much should you borrow?
Once you have the annual cost for school, subtract gift aid and any money your parents saved for college. If you’ve saved money for college, deduct that as well. The number you are left with is not only the direct school costs (tuition and housing), but also the costs needed to live while you are in school. If you have a job, consider how much of the above costs it will cover. At this point you should have final numbers on the cost.
That last number is the amount needed for the school loan. The less money you have to take out in school loans, the better. As you can see, the loan amount isn’t just about tuition and books. This should cover all the costs associated with being a student.
A caveat about student loans: Students will often take the full amount given, even when it’s not needed. If you do not need the entire amount, you can take only as much as is required. Borrowing more loan amount than required will attract higher interest and increase your monthly loan payment.
Main rule of thumb: Our main rule of thumb for how much you should borrow is to never borrow more than you expect to earn in your first year after graduation. This will help ensure that you never borrow too much and not be able to repay it.
If you want to dive into more exact numbers, you can enter all of your loans into this calculator and see what repayment looks like: How Much Student Loan Debt Can I Afford Calculator?
paying off your student loans
If you have federal student loans, there are a variety of repayment plans, such as income-driven repayment plans, that can help you pay off your student loans in an affordable way.
You should choose a repayment plan that you can afford to pay every month. If you don’t know where to start, consider using a tool like Student Loan Planner to help you.
The government offers many loan features that are not available with non-government loans. These include:
- Tolerance: You don’t need to start making payments on student loans until after you graduate.
- Difficulty: During repayment, you can defer payments until your financial situation improves.
- low interest: Most loans will have interest rates in the single digits.
- Low Origination Fee: The fee for loan disbursed is ~1% of the loan value.
- Loan Waiver Program: There are a variety of loan forgiveness programs that federal loans are eligible for.
Here are the repayment plan options at a glance:
If you’re enrolled at least half-time, you don’t need to start making payments on a government loan until six months after you graduate. Additionally, interest for subsidized loans will not accrue until graduation, but interest for unsubsidized loans will begin accruing immediately.
According to the latest student loan statistics, the average monthly payment is $503, while the average monthly payment is $290. How much you pay will depend on the repayment plan and interest rate. Note that graduate loans will typically have higher interest rates than graduate loans.
Private loans have no loan waiver option and moratorium rules are strict. You’ll inevitably have to make these payments, no matter what, like a mortgage or a car loan.
A necessity for most students
With tuition continuing to rise, student loans have become a necessity for any student wishing to attend college. While student loans can be a great source of financing for college, planning the costs and only taking out the amount needed will help avoid unnecessary debt.
