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October 3, 2019

The World of Student Loans – Types of Loans

by Shalmali Kulkarni

The process of planning for college, from filling out applications and applying for financial aid to finally seeing your child off at their new dorm, is a lengthy and arduous one. Not only do parents have to cope with the empty nester feeling when all is said and done, but they also have to figure out the best and most efficient way to pay for college without jeopardizing their own retirement. With rising tuition rates around the country, more and more parents are looking at student loans to help pay for their child’s college. Through our Student Loan Series, we aim to educate you about the types of loans available, the repayment plans out there and ultimately the best strategies to pay them off.

Let’s start with the basics. What is a student loan?

A student loan refers to any money borrowed to pay for school related expenses such as tuition, room and board fees, books, computers, etc. There are two main types of loans that you can take to pay for college: federal or private. A federal loan is a loan that is backed by the government. This typically has lower interest rates than a private loan and can also provide several payment protection plans for the borrower. A private loan is a loan backed by banks, credit unions and/or other private lenders. These will have a higher interest rate than a federal loan and also may not offer any protection for the borrower.

First, we’ll take a look at federal loans.

In order to qualify for a federal loan, you must complete the FAFSA – Free Application for Federal Student Aid. The FAFSA determines which type of federal loan you are eligible for and in what amount. In addition, the student needs to be enrolled in school at least half-time to be eligible for certain federal loans.

There are two main student loan programs:

1. The Direct Loan Program, which can be broken down into the following three types of loans:

a. Direct Subsidized Loans: These are available only to undergraduate students who have demonstrated finance need per the FAFSA. Under this loan, the government pays the interest while the child is in school as well as for the first six months after school or during any deferment periods. Repayment begins six months after graduating from school or dropping below half-time enrollment status. Standard repayment on a Direct Subsidized Loan is 10 years; however, you can qualify for a longer repayment term if you consolidate the loan or have more than $30,000 in federal loans debt.

b. Direct Unsubsidized Loans: These are available to undergraduate, graduate and professional students regardless of financial need. With this loan, interest starts accruing on the loan right from the beginning, even when the student is in school and it is ultimately the student’s responsibility to pay this interest back. Repayment begins six months after graduating from school or dropping below half-time enrollment status. Unsubsidized loans have a variety of repayment plans available to choose from. These include standard, graduated, extended and other income-based repayment plans.

c. Direct PLUS Loans: This is the only type of student loan available to parents of dependent students going to undergraduate school as well as graduate and professional students who need to borrow beyond the federal unsubsidized loan limit. This loan, like the unsubsidized loan, also accrues interest during the time the student is in school. The maximum loan amount available to the parent will be the cost of education minus any other financial aid received. Repayment on this loan begins immediately upon the last disbursement of the loan, i.e. when the student is still in school. Please note, in addition to the interest charges, Direct PLUS Loans also have a loan fee which is a percentage of the principal amount and is deducted at source. Thus, you will actually receive a lower amount in hand than you have to repay.

2. The Perkins Loan Program: This loan differs from other federal student loans in that the school is the lender and not the federal government. Under the federal law, the authority for schools to make new Perkin Loans ended on September 30th, 2017. As a result, students can no longer receive a Perkins Loan.

Now, we will move on to private loans.

Private loans are an alternative to federal student loans. However, these are generally more expensive and have higher variable rates as compared to federal loans. They should be tapped into only if you are not eligible for federal financial aid or have exhausted the maximum aid package available to you.

If you are required to take a private student loan, please consider the following:

1. Low credit score = higher interest rate on loan: The cost of your loan will be directly correlated to your credit score. Some lenders may also require a cosigner. Having a cosigner with good credit could potentially lower your interest rate.

2. Other fees: Many private loans also have additional fees that may increase your overall cost of borrowing. There may also be prepayment penalties if you pay off the loan early.

3. Repayment Options: With most private loan lenders, you have to start repaying the loan while the student is still in school. However, you can choose to only make interest payments during this period. Repayment terms can vary by lenders, and can be extended as far out as 25 years. Unfortunately, most private loans do not offer deferment, forbearance or loan forgiveness options. That said, you do have the option to refinance the loan to a lower interest rate in the future to reduce your payments.

4. Consolidation of Loans: Unlike federal loans, which can be consolidated together to lower your monthly payments and extend your payment term, private loans do not allow for consolidation. You can, however, refinance all your private student loans into one loan for ease of payments.

In this article we have covered the types of student loans available. Next, we will tackle the myriad of repayment options out there. Stay tuned for our Student Loan Series – Part 2.

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