Student Loans: University Enabler Or Debt Sentence?

Student loans are a form of financial aid intended to help students access higher education. In the US, student loans can be categorised into two types: federal student loans and private student loans. Federal student loans are loans from the government, whereas private student loans come from private sources such as banks or financial institutions.

Federal student loans are run by the US Department of Education and are the largest provider of student financial aid in the country. There are four types of federal student loans: direct subsidised loans, direct unsubsidised loans, direct PLUS loans, and direct consolidation loans.

Private student loans are usually significantly more expensive than federal student loans and typically come with much higher interest rates. The lender is not associated with the government and is free to decide their own interest rate and repayment terms.

Federal vs private student loans

Federal student loans are provided by the government, while private student loans are provided by banks, credit unions, and other financial institutions. Each has its own eligibility criteria, application process, and terms and conditions.

Federal Student Loans

Federal student loans are educational loans that are available through the U.S. Department of Education and come with various benefits that can make the repayment plan more affordable. Federal loans are either subsidised (the government pays the interest) or unsubsidised. Regardless of the federal loan type, the interest rate is the same for all borrowers, and they tend to have lower interest rates than private student loans.

There are three main types of federal student loans: Direct Subsidised Loans, Direct Unsubsidised Loans, and Direct PLUS Loans. Direct Subsidised Loans are available for undergraduate students with financial needs and they cover all accrued interest while the student is in school and during deferment and grace periods. Direct Unsubsidised Loans don't cover interest, but they're available for both undergraduate and graduate students, regardless of financial need. Direct PLUS Loans are offered to graduate students and parents of dependent undergraduate students, and they don't have a dollar-amount cap on how much you can borrow.

Benefits of Federal Student Loans

• Access to income-driven repayment plans: The Department of Education offers several income-driven repayment plans, which can reduce monthly payments to as little as 10% of discretionary income.
• Few to no credit requirements: Most federal student loans don't require a credit check.
• Discharge in the event of loss or disability: If a borrower becomes permanently disabled or dies, their federal student loan balance is automatically discharged.
• Generally less expensive: Federal student loans usually have lower interest rates and are likely to be cheaper, especially for students without a stable income or credit history.
• Access to student loan forgiveness: Federal student loans offer access to different loan forgiveness programs, such as Public Service Loan Forgiveness and Teacher Loan Forgiveness.

Drawbacks of Federal Student Loans

• Upfront fees: The federal government charges an upfront loan fee, which is relatively low for undergraduate students but high for graduate students and parents.
• Loan limits: Undergraduate students are limited in how much they can borrow, which may lead them to turn to private student loans.
• No choice of servicer: The Department of Education assigns a loan servicer automatically, and consolidating loans with another servicer can impact access to certain benefits and protections.

Private Student Loans

Private student loans are educational loans offered by private lenders, such as banks and credit unions, and they require a credit check. Approval and loan terms are dependent on the borrower's creditworthiness, and a cosigner may be needed to improve the chances of approval. Private student loans offer competitive rates for creditworthy borrowers, higher loan amounts (usually up to the total cost of attendance), and no upfront fees. The standard term for a private student loan is typically longer than that of a federal loan, ranging from 5 to 20 years.

Benefits of Private Student Loans

• Higher loan amounts: Private lenders may offer higher loan limits, giving borrowers more borrowing power.
• Chance for low-interest rates: Creditworthy borrowers, especially those with excellent credit, may get a lower interest rate through a private lender than through the federal government.
• No upfront fees: Private lenders typically don't charge upfront loan fees.
• More flexible loan terms: Private student loans may offer more flexibility in loan terms compared to federal loans.

Drawbacks of Private Student Loans

• Lack of protections: Private lenders usually don't offer student loan forgiveness programs, and most don't provide income-driven repayment plans.
• High-interest rates for most: Private loans require a credit check, so individuals with no credit history or a low credit score may end up with a more expensive loan.
• Harder to qualify: It can be challenging for students to get approved for private loans independently, and they may need a cosigner.
• Fewer repayment options: Private student loans often have less flexible payment terms than federal loans.

In summary, federal student loans are generally the preferred option due to their unique benefits and protections for borrowers. However, private student loans can be a good alternative if federal loans are insufficient to cover educational costs or if a borrower has exceptional credit and plans to pay off their loans quickly. It's important to carefully consider your financial situation and repayment options when choosing between federal and private student loans.

Undergraduate vs graduate student loans

Undergraduate and graduate student loans differ in several ways, and it's important to understand these differences to save money and avoid overwhelming debt. Here are the key differences between undergraduate and graduate student loans:

Dependency Status

Graduate students are considered independent on the FAFSA (Free Application for Federal Student Aid), simplifying the application process by not requiring parental financial information. Undergraduate students can also be considered independent in certain circumstances, but it is more common for graduate students.

Interest Rates on Federal Student Loans

Federal student loan interest rates for graduate students are higher than those for undergraduates. For the 2024-25 academic year, graduate student loan interest rates are 8.08% for Direct Unsubsidized Loans and 9.08% for Direct PLUS Loans, compared to 6.53% for federal undergraduate student loans. These rates are set by Congress and are subject to change annually.

Interest Rates on Private Student Loans

Private student loans are issued by private lenders or banks and are not backed by the federal government. Graduate students with an established credit history and/or steady income may qualify for more competitive interest rates on private student loans compared to undergraduates, who are often new to credit and lending. However, private student loans generally lack the borrower protections offered by federal loans, such as income-driven repayment plans or loan forgiveness options.

Borrowing Limits

Graduate students have significantly higher borrowing limits than undergraduates. Graduate students can borrow up to $20,500 annually in Direct Unsubsidized Loans, with a lifetime cap of $138,500 when combined with undergraduate loans. In contrast, undergraduates are typically capped at $5,500-$7,500 per year, with a total availability of $31,000. Graduate students in certain health fields may have an even higher lifetime limit of up to $224,000.

Subsidized vs Unsubsidized Loans

Undergraduate students may receive subsidized loans, where interest does not accrue while they are full-time students. In contrast, graduate student loans do not have subsidized options, meaning interest accrues immediately, even during their studies. This can result in a larger debt burden for graduate students, especially if they take longer to complete their degree.

Student Loan Refinancing

Student loan refinancing is more commonly considered by graduate students due to their potentially stronger credit history and higher earning potential after graduation. Refinancing allows borrowers to qualify for lower interest rates, but it is important to note that refinancing federal loans into private loans results in the loss of federal benefits, such as income-driven repayment plans and loan deferment.

In summary, graduate student loans generally have higher interest rates and borrowing limits compared to undergraduate loans. Graduate students are also more likely to have unsubsidized loans, accruing interest from the moment the loan is disbursed. While graduate students may have access to higher borrowing limits and potentially lower interest rates on private loans, careful consideration is necessary to avoid accumulating overwhelming debt.

Student loan repayment options

Overview

Student loan borrowers can choose from four types of federal student loan repayment plans. The best repayment plan for an individual will likely be the standard repayment plan or an income-driven repayment plan, depending on their goals.

Standard Repayment Plan

The standard repayment plan is best for those who want to pay less interest over time. On this plan, equal monthly payments are made for 10 years. This is the default repayment plan that borrowers are automatically placed on when they enter repayment.

Income-Driven Repayment (IDR) Plan

The government offers four IDR plans: income-based repayment, income-contingent repayment, Pay As You Earn (PAYE), and Saving on a Valuable Education (SAVE). IDR plans are best for those with low incomes who cannot afford the standard repayment plan. IDR plans set monthly payments at between 10% and 20% of the borrower's discretionary income. Payments can be as low as $0 for those who are unemployed or underemployed, and they can change annually. IDR plans extend the loan term to 20 or 25 years, after which any remaining debt is forgiven, although it may be taxable.

Graduated Repayment Plan

The graduated repayment plan is best for those with high incomes who want lower payments. This plan decreases payments at the beginning of the loan term, potentially to as little as the interest accruing on the loan, and then increases them every two years, with repayment completed in 10 years.

Extended Repayment Plan

The extended repayment plan is best for those who do not want payments tied to their income. This plan lowers payments by extending the repayment period to as long as 25 years. Borrowers must owe more than $30,000 in federal student loans to qualify. The extended repayment plan does not offer loan forgiveness, and borrowers will pay off the loan completely by the end of the repayment term.

Private Student Loans

Private student loans do not qualify for income-driven repayment plans. However, some lenders offer student loan repayment options that temporarily reduce payments. Those struggling to repay private student loans should contact their lender to ask about their options.

Student loan discharge

Student loan debt has proliferated since 2006, reaching a total of $1.73 trillion by July 2021. In the US, student loans are a form of financial aid to help students access higher education. While notable exceptions exist, student loans generally must be repaid, unlike scholarships and grants.

Additionally, there are provisions for loan discharge for individuals with total and permanent disabilities (TPD). If an individual receives a TPD discharge, they are no longer required to repay their federal student loans. The TPD discharge applies to several types of federal student loans, including Direct Loans, Federal Family Education Loans, and Federal Perkins Loans. To qualify for a TPD discharge, individuals must provide supporting documentation showing that they are totally and permanently disabled. This can be done through documentation from the US Department of Veterans Affairs, the Social Security Administration, or a licensed medical professional's certification.

Furthermore, certain teachers may qualify for student loan discharge. Teachers in specific critical subjects or in schools with a high percentage of students on reduced-price lunch may be eligible for discharge of certain types of federal student loans up to a certain amount.

Another option for student loan discharge is through public service. Individuals employed full-time by a non-profit organisation or serving in a qualifying position, such as AmeriCorps or the Peace Corps, may qualify for loan discharge after a certain number of qualifying payments. However, it is important to note that loan discharge is typically considered taxable income.

Student loan applications

Applying for a student loan can be a complicated process. There are several steps and pieces of information required from students and their families. Here is a guide to help you prepare for and navigate any student loan application process.

Applying for Federal Student Loans

The first step in applying for federal student loans, such as Direct Subsidized and Direct Unsubsidized Loans, is to complete the FAFSA (Free Application for Federal Student Aid). You can create a studentaid.gov account and gather the necessary personal and financial information, such as your Social Security number, records of child support received, current balances of cash and investments, and the names of schools you wish to attend. After submitting the FAFSA, you will receive a summary of the reported information, and the listed schools will have access to your FAFSA details. These schools will then send you a financial aid offer outlining the type and amount of aid you are eligible for.

Types of Federal Loans

There are three types of federal student loans:

• Direct Subsidized Loans: Offered to undergraduate students with financial need. The loan amount is determined by the college and cannot exceed your financial need. The US Department of Education pays the interest on these loans while you are in school.
• Direct Unsubsidized Loans: Available to undergraduate and graduate students without the requirement to demonstrate financial need. Borrowers are responsible for paying the interest, which accrues on the loan.
• Direct PLUS Loans: Often referred to as Parent PLUS loans, these are available to graduate or professional students and parents of dependent undergraduate students. The maximum loan amount is the cost of attendance minus any other financial aid received.

Applying for a Private Student Loan

Private student loan lenders require similar information from applicants. The application process may vary, but the following is a general list of what you will need to provide:

• Driver's license number
• Social Security number or Alien ID number for permanent residents
• Gross monthly income and recent pay stubs
• Employer information
• Monthly rent or mortgage payments
• Anticipated graduation date
• Loan amount requested and loan period
• Cosigner and student borrower reference information

Private lenders may ask you to submit documents to verify the provided information. Once approved, you will need to sign a promissory note detailing the loan terms. After accepting the loan and completing the necessary documents, the lender will typically send the funds directly to your school.

Tips Before Applying for a Private Student Loan

There are several things you can do to streamline the private student loan application process:

• Finding a cosigner: If you have little to no credit history or a poor credit score, you may need a cosigner on your loan.
• Researching rates: Compare interest rates from multiple lenders and check if your degree program or state affects the loan type you are offered. Federal student loans usually have fixed, lower interest rates than private loans.
• Improving credit: A higher credit score can increase your chances of loan approval and may help you secure a lower interest rate.

Frequently asked questions