Word of the Week
Interest (n). The fee you pay for borrowing money as part of an educational loan. Usually, interest is charged monthly. The fee is calculated as a percentage of the total amount you borrowed, also called the interest rate. For example, if the interest rate is 3.4%, and your monthly payment is $100, you owe an additional $3.40 each month, for a total payment of $103.40 per month.
Much of the information in the media about college loans is terrifying. Stories about students and graduates unable to find jobs and drowning in debt seem commonplace. National student loan debt recently surpassed credit card debt. However, not all loans are made alike, and sometimes borrowing money is a good decision that allows a student to attend his or her best fit college. The key is to understand the different types of loans, choose the least expensive loans, and to understand the size of payments post-graduation.
Types of Loans
Just like scholarships, loans are financed by a number of different agencies. Who provides the funding for the loan can change how expensive the loan will be for the borrower. Some loans are also only available to families who demonstrate financial need.
Choose loans that will be the least expensive to repay. Usually, federally funded loans with interest rates that don’t change are the best choice. Big Future at the College Board has a helpful chart comparing loan types and interest rates.
Federal Government Loans—Need Based
These loans are awarded by the college/university to students with the highest amount of financial need.
Interest rate: 5.0% (fixed)
These loans are subsidized, which means the federal government pays the interest while the student is enrolled in school. Students must begin re-paying the loan with interest six months after they are no longer enrolled at least half-time in college.
Interest rate: 3.4% (fixed)
Federal Government Loans—Not Need Based
While the government provides the funding for these loans, they are not subsidized, which means students are responsible for paying the interest that adds up while the student is enrolled in college. Over time, the student ends up paying more.
Unlike all the other types of loans listed here, these loans are available to parents or guardians. Parents can borrow the entire amount of a college education minus other financial aid.
Interest rate: 7.9% (fixed)
Some states also finance educational loans. While Washington DC does not operate a loan program for students, students may be eligible for a college loan from the state they attend college. For examples, see MEFA Loans in Massachusetts and NJCLASS Loans in New Jersey. The U.S. Department of Education also provides a list of all U.S. State Boards of Higher Education.
There are other ways to borrow money for college. Private loans, sometimes referred to as alternative loans, are not sponsored by the government and often have higher interest rates than federal loans. Students and families pay more over time. Private loans should be a last option.
- Banks offer a range of private loans with varying interest rates. They often require a parent or guardian to cosign with a student. The parent is therefore responsible for the loan repayment if the student cannot pay.
- Some colleges and universities may also offer loans as part of their financial aid package. Make sure to ask about the interest rate and repayment terms of the loan.
No Loans are Free
All loans must eventually be repaid, so it’s important for students to fully understand what current borrowing choices will mean for their future. In most cases, it is the student’s responsibility alone to pay back a college loan. As a family, it is important to discuss post-college graduation budgeting and financial planning. Consider these questions:
- If the parents decide to take out a Parent PLUS Loan or other private loan that requires repayment to begin immediately on a monthly basis, is it a feasible within the family’s budget (including if an unexpected expense occurs such car home maintenance, medical emergency, etc.)?
- How much will the student’s total loan payment(s) be after college?
- Using estimated expenses for necessities such as housing, food, and transportation, how much will the student need to earn directly after college in order to meet monthly loan payments?
- Is the resulting salary figure a realistic number for a new college graduate? If not, the college in consideration might not be the best financial choice.
A few programs allow borrowers in certain fields to qualify for loan forgiveness.
- Borrowers who pursue a career in public service are eligible for loan forgiveness of Federal Direct Subsidized and Unsubsidized Loans after 10 years if they have made 120 monthly payments towards the balance of the loan. Public service includes federal, state, and local government work, employment with tax-exempt non-profit organizations, and certain private organizations that provide public service such as the military, health providers, and emergency response workers.
- Borrowers who teach in certain low-income schools full-time for five consecutive years may be eligible for loan forgiveness or loan cancellation. The Federal Direct Subsidized and Unsubsidized Loans and Perkins Loans are eligible loans for this program.
Tools: Loan Calculators
Loan calculators provide a figure for expected monthly repayment, based on the amount of a loan, designated interest rate, and selected repayment schedule.
Still have questions about loans? Leave us a comment here or send us an email: firstname.lastname@example.org.
Please remember that this post is intended for informational purposes. Always consult the college/university financial aid office and/or a tax professional for financial advice.