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With Back-to-School season approaching, there’s no time like the present to go over the ABC’s of student loans! If you (or your kids) are looking into student loans for the coming school year, this post is for you! Before you accept any student loans, be sure to understand the following concepts and decide which options work best for you.
Federal vs. Private Loans
The first big decision you need to make is whether you want to take out federal loans, private loans, or a mixture of the two. Both kinds have their merits, but understanding the key differences can help you decide which type of student loan will work best for you.
Federal Student Loans are extended by the U.S. Government, and typically have lower, fixed interest rates compared to private loans. One of the main benefits is that you aren’t required to make any payments while you’re in school, and generally once you’re in repayment, the interest is tax deductible. Showing a financial need can qualify you for these loans without having good credit or a cosigner, except in the case of PLUS loans, which are taken out by a parent on your behalf.
Federal loans offer a wide variety of repayment plans, including income-driven repayment plans and options for forbearance and deferment, which allow you to temporarily stop making payments on your student loans. Other benefits include potential loan forgiveness when working in public service, and no prepayment penalties; this means you can pay off your loans early without paying additional fees!
If you don’t qualify for Federal loans or they don’t cover enough of your tuition, you might consider taking out Private Student Loans. These loans are extended by private banks and credit institutions, and generally have higher interest rates, as well as variable interest rates that can sometimes be higher than credit cards. The upside is that more money is available to you than what the federal government is willing to loan you, but the downside is that these loans are almost always more expensive.
The other main downside to private loans is that many require payments while you’re in school, and many have prepayment penalties as well; be sure to do the research on these factors before applying. The interest may not be tax deductible, the payment plans are less flexible, and there are no options for loan forgiveness, forbearance, or deferment. Taking out private loans means that they will typically run your credit, meaning that most young people will end up paying more due to low credit scores or require a cosigner.
Overall, my standard advice is to max out your federal student loan options before considering going private, but if you do need to take out private loans, do your homework to find the lowest, fixed interest rates and most flexible repayment plans – your wallet will thank you for it later!
Subsidized vs. Unsubsidized
Now that we’ve established that Federal loans are typically the better option, let’s talk about the two main types of federal student loans and the differences between them.
“Subsidized” means that the Federal Government will pay the interest on your loans while you’re in school and anytime your loans are deferred (during forbearance, you still pay the interest). While subsidized loans are only available for undergraduate students, having your interest taken care of while in school is a huge bonus; this can add up to thousands of dollars you won’t have to pay down the road, so always consider accepting these loans first. Also called “Direct” or “Stafford” loans, Subsidized Federal Student Loans do require you to show more proof of financial need than other types of loans, and typically offer less money to students than their unsubsidized alternatives.
“Unsubsidized” means that your interest starts accruing the moment you accept the loan. This may not strike you as significant, but if you take out an Unsubsidized Federal Student Loan your first semester of college, spend another 4 years in school, and then defer your loans while you attend grad school, you could be accruing interest on that loan for 7 years before you even start to make payments. On a $5,000 loan at 4% interest, you’ve just racked up an additional $1,400 in interest!
While accrued interest is a scary concept, the benefit to unsubsidized loans is that they can typically offer you more money than a subsidized loan, so this is still a valid option for supplementing your tuition. Because the amount you can borrow on an unsubsidized loan is much higher, most people wind up having a combination of the two; I personally took out both because the subsidized loans didn’t offer enough, but making an informed decision is half the battle when it comes to student loans.
How Much Do You Need?
Now that we’ve covered Federal vs. Private and Subsidized vs. Unsubsidized loans, the last part of the equation is only accepting what you actually need. I emphasize this word because it means different things to different people; do you “need” spending money, or can you get a part-time job for that? Do you “need” money for books, or do you have some graduation money set aside for those? I encourage you to take an honest look at what school actually costs; that single dorm room might sound nice, but having a couple of roommates to cut costs could mean thousands of dollars in savings down the road. Anything you borrow now is going to catch up with you sooner rather than later, so I urge you to avoid taking out more than what’s necessary.
My last bit of advice is one that I wish I could shout from the rooftops, because I’m frankly appalled that this fact isn’t advertised, but it’s a solid option when you realize you’ve accepted more than you need. Did you know that you can return any unused portion of your student loans? Rather than racking up interest and paying it off later, simply talk to your financial aid office and submit a request for cancellation.
There are time limits on this option; typically after 120 days you’re responsible for any interest or fees associated with that money, but if you return it before then, it’s like you never accepted that money in the first place! I understand the temptation to pad your bank account and use that money for a spring break trip, but keep in mind that you’ll be paying for that trip, with interest, ten years from now.
At the end of the day, making a well-researched, informed decision is going to put you miles ahead when it comes to your student loans and your financial future, so do your homework (pun intended) and go back to school with confidence!
If your kids are too young to worry about student loans yet, check out more great back-to-school deals here!