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    Student Loans 101: A Guide to College Loans

    Thinking about taking out student loans to pay for college? Here's what you need to know before you sign on the dotted line.

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    Student Loans 101: Thinking about financing your child’s education or taking out student loans to pay for college? Here’s what you need to know before you sign on the dotted line.

    Student loans are a good way to pay for expenses while attending college, but they may not be right for everyone.

    Loans, unlike grants, do need to be repaid once you are done with college.


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    That’s why students may want to limit the total amount of student loans that they borrow or may want to only get loans that are subsidized.

    Whether a soon-to-be freshman or looking into graduate programs here are some basics about receiving and repaying student loans to consider before borrowing.

    Types of student loans

    There are two types of student loans: federal and private.

    Federal loans

    A federal loan stands for a loan that you borrow from the government. You are basically using the taxpayers’ money to get your college or university degree, hence repaying federal loans come with a different level of responsibility altogether.

    However, since interest rates are comparatively lower in federal loans and one does not require having a great credit score, most students take a lax approach when the time comes for repayment. You will also find options for paying as per your level of income or alternative repayment options if you apply for federal loans.

    • Subsidized Federal Loans: The federal government pays the interest for Direct Subsidized Loans while the student is in college or while the loan is in deferment. Interest begins accruing for Direct Unsubsidized Loans as soon as the loan is taken out.
    • Unsubsidized Federal Loans: Students are responsible for paying all of the interest that adds up until the loan balance is paid off. DirectUnsubsidized Loans (sometimes called Unsubsidized Stafford Loans) are low-cost, fixed-rate federal student loans available to both undergraduate and graduate students.
    • Parent Loans: PLUS loans are federal loans that graduate or professional students and parents of dependent undergraduate students can use to help pay for college or career school. PLUS loans can help pay for education expenses not covered by other financial aid.

    Independent students are students who are over the age of 24, married or have a child. Independent students are eligible to receive loans based on their financial status and are often offered a combination of subsidized and unsubsidized loans.

    Subsidized loans are a good choice because they incur no interest while you attend school and repay the loan after graduation.

    Federal unsubsidized loans generally have a lower rate of interest than other types of loans, allowing students to take advantage of the low-interest rates to continue their education.

    Private loans

    In case you opt for a private student loan, a credit union, bank or online lender provides you with the money that you need to pay your way through getting a higher education degree. They can have varying rates of interest (that is usually dependent on the loan provider and the type of interest you choose) and have comparatively rigid repayment options.

    However, since the rules regarding what you do with the loan money are quite lax in case of private loans, you can come up with ingenious tricks to pay it off way before it starts accumulating interest.

    Repaying student loans

    Repaying student loans doesn’t begin until you leave college or you graduate.

    Most federal loans also have a six month deferment period that allows you to find and begin a job to ensure you can repay the loan amounts successfully.

    The amount that you repay each month is based on the total amount of the loans that you received throughout your education.

    Many people try to take the minimum amount possible to reduce their monthly loan repayment, while others use the full amount of student loans to assist them with living expenses.

    Consider the repayment period when deciding whether student loans are right for you, as well as the total amount that you need to complete college successfully.

    You can refer to this useful guide on tips for paying student loans off faster.

    There are a variety of student loan programs offered by both federal and state governments. Most of these programs are based on occupations such as work for government, teaching, or military for example. Others include forgiveness programs based on income such as the Federal Income Based Repayment program or the Pay as You Earn Program.

    These loan forgiveness programs are especially helpful when you have bills that total up to more than 10% of your discretionary income. Other student loan programs are sponsored by state governments such as the Maryland SmartBuy Home Buyer Assistance & Forgiveness Program or the Janet L. Hoffman Loan Assistance Repayment Program.

    Standard Payment Plans

    If you took out:

    Or almost any other loan out there, you were probably automatically enrolled in a standard payment plan as soon as your grace period ended.

    These loans are paid back over 10 years and will typically be the option that offers you to get out of debt the fastest but have the highest payment.

    This may not always be your best option though.

    Income-driven plans, or plans that make it easier for federal student loan borrowers to pay back loans if your debt is high compared to your income, were designed for those facing financial hardship upon graduation (which pretty much describes nearly all graduates these days).

    Instead of simply calculating the payment period over three years, the government will calculate your payment based on a percentage of your income.

    With an income-driven plan, it could take a while longer to pay down your debt (if you only pay the minimum monthly payment), but it can significantly lower your monthly payment if you have a high balance.

    Plus, on some payment plans, when the interest owed exceeds the monthly payment, the government with cover the shortfall for three years or more.

    Income-Driven Plans

    You might be thinking, “I can afford to pay the standard payment. Why should I consider an income-driven plan?”

    Good question!

    Everybody knows that you should pay down the loan with the highest interest rate first.

    What you may not know is that using an income-driven repayment plan can still have benefits even if you can afford the standard payment plan, since an income-driven plan lowers your monthly payment across all of your loans.

    “Won’t I pay the same amount of interest either way?” you might be asking yourself.

    Not necessarily.

    Because your required payment is lowered, you now have more cash free to pay down your higher interest loan. This is especially meaningful if you have large differences in your interest rates.

    Examples

    Let’s look at an example of someone with $100,000 of student loans spread equally at 8.75%, and 4% and the differences an income-driven plan can make.

    In this case, we are going to assume the borrower is eligible for Revised Pay AS You Earn (REPAYE) which caps payments at 10% of income.

     Plan Standard Payment REPAYE Amount Saved
    Monthly Payment $1,150 $266
    Additional Payment $884
    Payback Period 10 Years 9 Years 1 Year
    Interest Paid $38,000 $23,251 $14,749

    Using REPAYE and paying $884 per month to the higher interest loan allowed this borrower to save almost $15,000 in interest payments!

    This could go a long way toward a down payment on a house or even buy a nice car!

    While Income Driven Plans aren’t for everyone, I hope you can see the benefits and the flexibility that they can create for many borrowers.

    Please see the table below for more details and specifics on the three most commonly used plans.

    As always, be sure to contact a financial planner about which one is right for you.

    The Three Types of Income-driven Student Loan Repayment Plans

    Plan PAYE IBR REPAYE
    What is it? Pay as You Earn –

    Limits payments to the lower of 10% of borrower’s income or the standard payment plan.

    Income-Based Repayment –

    Limits payments to the lower of 15% of borrower’s income or the standard payment plan.

    Revised Pay as You Earn –

    Limits payments to 15% of borrower’s (family if married filing joint) income.

    Interest Adjustment The government pays the first three years of interest on subsidized loans in excess of monthly payment The government pays the first three years of interest on subsidized loans in excess of monthly payment Government Covers First Three Years of Interest on subsidized loans not covered by payment and 50% of interest not covered thereafter.
    Taxable Forgiveness Taxable Loan Forgiveness After 20 Years Taxable Loan Forgiveness After 25 Years Taxable Loan Forgiveness After 25 Years
    PSLF Forgiveness Qualifies after 10 Years Qualifies after 10 Years Qualifies after 10 Years
    Qualifying Loans
    Federal Direct Loans
    FFEL Loans* X X X
    Perkins Loans* X X X
    Parent Plus Loans* X X X
    Private Loans X X X

    *Can be eligible if consolidated into a Federal Direct Consolidation Loan

    Public student loan forgiveness

    Public student loan forgiveness (PSLF) was created in 2007 in order to encourage graduates to pursue full-time work in public sectors including nonprofits and government organizations.

    If you are working in one of these fields, and have been consistent with your payments, it’s best to weigh your options and see if refinancing or PSLF will save you more money over the life on your student loan.

    Another option that very few are eligible for, but still may be worth looking into is legally getting your student loans discharged. You can learn if you’re eligible by reading our recently published post here.

    Should you refinance student loans?

    After you graduate, you’ll have the option of refinancing your student loans.

    Over 94,000 people refinanced their student loans last year—saving an average of $18,668 according to CNBC.

    You should usually opt to refinance your student loans if you have a high-interest rate on your student loans.

    Fortunately, for many graduates, refinancing can be a great opportunity to help with loan payments. If you have federal or private student loans with an interest rate over 4%, then refinancing them will save you a lot of money.

    Student loans with 6.8% interest rates mean that you’ll need to pay $586 a month in interest alone for every $100,000 you owe.

    You could also refinance your student loans to a longer term to help lower your monthly payments.

    It’s very simple to check your rate and it can save you a lot of money. You can see the top lenders for 2020 in this student loan refinancing guide.

    Good luck with your student loans, and if you have any questions about the Student Loans 101 guide feel free to contact us or ask in the comments section below.

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