Borrowing For Beginners: An Introduction to Student Loans
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If you’re in the process of planning for college, the question of how you and your family will pay for this major expense is likely on your mind. Most families will end up needing some kind of help in order to afford college, and while options for need-based financial aid grants and merit-based scholarships exist, sometimes these aren’t enough to close the gap.
This is where student loans come in. Borrowing money to help pay for college is a tool that many students use to make college a more practical possibility. Taking out student loans isn’t without its risks, but if you do your research and make careful decisions about what you’re able and willing to take on, you may find that student loans are just what you need.
Read on for a beginner’s guide to the basics of the student loan process, how to find and evaluate student loan options, and what to expect with regard to repaying your loans in the future.
What is a student loan?
A student loan, in its most basic sense, is a sum of money that you borrow to help pay for your post-secondary education. Student loans can only be used for educational costs, but often, this can include the expenses that are necessary in order to make your education possible, such as housing, meal plans, and books. (Check out our post Tuition vs. Cost of Attendance: Understanding Your College Expenses for more details.)
Unlike grant-based financial aid, student loans have to be paid back according to policies determined by the lender. As with most formal loans, your student loan debt will also accumulate interest, so the total amount you end up repaying over time will be greater than the amount you initially borrowed.
It’s important to understand that taking out student loans represents a major financial commitment that will likely affect your life for years to come. Your repayment plan may last a decade or more, and while options exist to delay repayment, that will cause more interest to accumulate and increase your overall cost. Unlike many other forms of debt, student loans can’t be discharged even if you declare bankruptcy later in life. If you have a cosigner, their life may be affected as well.
However, the gravity of the student loan commitment doesn’t mean that you shouldn’t consider the option — after all, a college education and a bachelor’s degree are still valuable assets. As college costs continue to rise, student loans can be an important financial tool that can make college a more feasible option for you and your family.
One silver lining to consider is that making payments on your student loans can help to improve your credit score, which others can use to estimate whether you’re reliable in paying off your debt. Many teenagers aren’t yet thinking about their credit scores, but these numbers may become important later on when you’re looking for housing, signing up for utilities, or buying a car or a home.
In order for you to be an informed borrower, you need to do your research and fully understand what you’re agreeing to when you sign your promissory note, the legal paperwork for your loan. Student loans have both risks and rewards, and there’s a lot of variation in the terms of different student loans, so your loan may not be the same as a friend’s or a classmate’s.
Obviously, we can’t cover all the details of all available loan options in one post — there are simply too many variations to consider. However, we hope this post can help you better understand the topic of student loans in general, so that when you undertake your own research and survey your own loan options, you’re able to do so with more confidence that you’re making good decisions.
Types of Student Loans
Within the world of student loans, you’ll find two major categories: government loans and private loans. Here’s a brief introduction to what that distinction means and what kinds of loans you’ll find classified under each heading.
Federal Student Loans
Qualified students can borrow student loan funds from the federal government, known as Direct Loans, through the Federal Student Aid program administered by the U.S. Department of Education. (These were formerly known as Stafford Loans, and some people may still use that name for them.)
Student loans offered by the federal government come with certain benefits. Interest rates are typically fixed, meaning they’ll stay the same over the life of the loan, giving you a better idea of what to expect. You’ll also potentially have access to greater flexibility with regards to the repayment process.
The flip side of these benefits is that if you fail to pay back your student loans as instructed, the consequences can be especially severe. They could include having your wages garnished or your tax refund withheld if your loan payments aren’t made.
There are two kinds of federal student loans: subsidized and unsubsidized. They differ in how they treat the interest on your loan. If you take out a subsidized loan, the Department of Education will pay off the interest that accumulates on your loan while you’re still in school, meaning that that interest won’t add to your overall cost. If you take out an unsubsidized loan, you won’t receive this benefit, so your interest will accumulate while you’re in school and add to your overall debt.
Your federal loan eligibility is dependent upon a few different factors. One is your cost of attending college, as calculated by your school. Another is financial need (as determined by the FAFSA), which is required in order for you to access subsidized loans. There are also yearly and overall limits to how much you can borrow.
In addition to federal government loans, some state governments offer their own loan programs. For example, the Massachusetts Educational Financing Authority, or MEFA, is a state authority which offers student loan opportunities to undergraduates who either are legal residents of Massachusetts or are attending college in Massachusetts.
Each state with a student loan program has different requirements and a different application process for that program, so you’ll need to do some additional research to find out what your state might offer. These state loan programs may offer some of the benefits of federal loans, but not necessarily all of them.
Private Student Loans
Private student loans are borrowed from a privately owned source, such as a bank, credit union, or private college. These loans all have their own application procedures and requirements, so it’s difficult to make broad statements about them as a category.
What we can say is that private loans aren’t subject to the same regulations as federal loans, so they’re often less borrower-friendly. They aren’t subsidized, and they generally offer less flexibility in the repayment process. They’re also more likely to come with variable interest rates, meaning that your interest rate may change at some later point in the life of the loan and may result in you owing more than you anticipated.
Another thing to keep in mind is that unlike Federal Direct loans, private student loans take your credit history into account. Since most high school students haven’t had the chance yet to build up their credit, this may mean that you’ll need a cosigner, such as a parent or other relative, in order to have your loan application accepted. That cosigner will bear some legal responsibility for repaying the loan if you fail to do so, and it can be challenging to find someone in your life who’s willing to take on this role.
While federal loans are often a better option for college students, they come with limits and eligibility restrictions, and may not be enough to meet your needs. Private student loans can fill in the gaps and offer more flexibility as you figure out how you and your family will finance your education.
Parent Loans for College Expenses
When you research student loans, you may also find information about parent loans that are available for educational expenses. These loans are different from student loans in that they’re taken out in your parent’s name, not in your own name. Therefore, you’re not the one who’s legally responsible for paying them back.
We won’t cover these sorts of loans in detail here, but parent loans may be an option for helping your family to finance your education. Just as with student loans, you’ll need to do careful research and discuss the matter with your family. You’ll also need to remember that asking your parent(s) to go into debt to pay for your education is a big deal, and you’ll need to take it just as seriously as if you were the borrower yourself.
How to Seek Out Student Loans
Before you explore taking out student loans, you’ll need to be sure that you’ve exhausted your other financial aid options. Grants and scholarships that don’t require repayment are generally better options than loans, if you’re able to access them. If you’re confident that you’ve fully explored other funding avenues, however, and you still need more help in paying for college, it’s time to consider student loans.
Since governmental loans generally have better terms and repayment options, you’ll want to start with the federal Direct Loan program if you’re eligible for it. To apply for both subsidized and unsubsidized loans, you’ll first need to submit the Free Application for Federal Student Aid, or FAFSA. (Take a look at our Ultimate Guide to Filling Out the FAFSA for more information on what this entails.) Deadlines will vary by state and school, but it’s generally advisable for you to fill out the FAFSA as early as possible.
The FAFSA will determine your financial need, which will in turn determine whether you’re eligible for subsidized Direct Loans. The information from your FAFSA will also be forwarded to your school, which will help to determine how much total Direct Loan funding you’re eligible to access based on your calculated cost of attendance.
When you receive your financial aid award letter from your college, it will list how much and what type of Direct Loan funding you’ll receive if you attend that school. You won’t be required to submit any additional loan application, though you’ll have to attend informational entrance counseling and sign a promissory note (a formal loan agreement) before receiving your loan.
Once you’ve determined how much you can expect to receive from the federal Direct Loan program, you can decide whether you need to seek out other private loans as well. If you and your family conclude that this is the right choice for you, you’ll need to start the process of looking for a lender. (Remember, you’ll probably need a cosigner, so you’ll need to talk this over with your family well in advance.)
There are a lot of different ways to go about seeking private student loans, and there are many different companies that offer and administer private student loans. You or your family may already have a relationship with a bank or other lender that you or they would like to utilize. Your college may be able to provide you with a list of “preferred” lenders with whom they frequently work. Ultimately, however, the choice is up to you.
You and your parents may want to talk to other families who have sought out private student loans in order to get suggestions. In this day and age, you can even look up reviews and rankings of private lenders online. Keep in mind that your loan’s terms will depend upon a number of factors that are personal to you, so you may not receive the same loan terms as the person who recommended that lender to you.
If you apply for a private student loan, you’ll have the opportunity to review the lender’s offer and potentially compare it to others before you commit. Later in this post, we’ll go over the factors that you’ll need to take into account when determining whether any loan — federal or private — is a wise financial move for you.
Planning for the Loan Repayment Process: What to Expect
At some point after you take out your student loans, you’ll need to start paying them back. When this repayment period begins and what it entails depends on your loan.
Federal loans can be deferred until you finish school, and often also offer a grace period between when you leave school and when your payments begin. On the opposite side of the spectrum, some private loans may require you to start making payments immediately after taking out your loan. (Check the fine print to make sure.)
Once repayment starts, you’ll make monthly payments until the loan is repaid. The amount you pay each month will depend upon the amount you owe and the terms of your loan agreement. Just like most other debts, your student loan debt will accumulate interest over time, so you’ll repay a larger amount than you borrowed.
As we’ve mentioned, federal loans often allow for more flexibility in repayment than private loans. For example, you might have the option of a graduated payment plan, in which your payments are scheduled to be lower at first and rise over time. You might also be able to stop paying on your loans for a while if you go back to school or hit a financial rough patch. Either of these options involves paperwork and proof of your school enrollment or financial situation.
Student loans are a very serious commitment, and you should bear in mind that breaking that commitment by not making your scheduled payments sets you up for serious consequences, particularly when it comes to federal loans. (Some loan servicers may be amenable to making special arrangements in dire circumstances, but you’ll need to be proactive about approaching them when you’re in a bad spot and asking for accommodations.)
One more thing to consider is the existence of loan forgiveness programs, in which your federal student loans may be forgiven if you spend a certain period of time working in certain fields, such as social work or teaching, in a geographical area that’s particularly in need of those services.
Loan forgiveness programs can be complicated and have very specific requirements, so if you’re considering this option, you’ll need to do more research before depending upon it. However, if you’re interested in these career fields, loan forgiveness programs can not only help you afford your college education, but also help you to help others by filling valuable roles that benefit communities.
Should loans be a deciding factor in where I apply to or attend college?
There are many different factors that come into play when you’re choosing a college, from educational quality to location to the “feel” of the campus. Realistically speaking, however, the cost of college matters a great deal to applicants and their families, and that factor helps decide which colleges it will be practically possible for you to attend.
Student loans are only one factor among many that determine what and how you’ll pay for college, but your loan options may help to mitigate some of the costs and determine whether a particular college makes financial sense for you and your family. In that sense, they may be a deciding factor in where you end up attending college.
Obviously, when it comes to financial aid and funding options, student loans have their downsides, the most obvious being the long-term repayment commitment they involve. Scholarships and grants that you don’t have to pay back in the future and that don’t accumulate interest are often more attractive options than loans, and if you need help paying for college, you should definitely research and apply for grant aid.
However, scholarships and grants aren’t always available, and competition for that type of aid can be fierce. If you plan carefully and make wise decisions, student loans can fill the gap, potentially allowing you to attend a higher-quality college or one that’s a better fit for you. This can improve your future prospects and give you valuable opportunities to achieve your goals.
It’s clear that loans can be a deciding factor in determining where you eventually attend college, but should your loan options dictate where you apply to college? That’s a more complicated question.
Financial aid awards usually can’t be determined by colleges until admissions decisions are made, so you generally won’t know how much it will cost you to attend each of your college choices until late in the admissions process. Similarly, your eligibility for student loans is often not determined until you go through the loan application process via the FAFSA and (if applicable) a private lender, so it’s not usually possible to determine your loan options in advance.
If a certain college appears very likely to be excessively expensive for you to attend, you might reasonably choose not to apply there in order to spare yourself that disappointment. This is especially true if you plan to go into a career field that’s on the lower end of the pay scale or has limited job opportunities, and you’re worried that you’ll have a hard time making substantial loan payments.
However, you might also choose to take the chance, apply to the college, and hope you’ll be awarded a financial aid package or scholarships that will make the cost manageable for you and your family. You can explore your loan options later on, depending upon what other aid you might receive.
Either way, the best way to approach this situation is to get informed and keep your expectations reasonable. Talk to your family about your financial resources, research your funding and financial aid options, and make backup plans for what to do if your favorite colleges aren’t financially within reach. (Our post You Were Accepted to Your Dream College, but Can’t Afford it… Now What? is a great resource when it comes to exploring your options when your top-choice college isn’t financially feasible.)
Questions to Ask Before Agreeing to a Student Loan
Obviously, the subject of student loans is a complex one, and there’s far more to the topic than we could possibly cover in one short blog post.
However, to get you started on the right foot, here’s a quick summary of the basic things that you’ll need to find out about any student loan that you’re considering:
- What is the principal, or initial amount, of the loan?
- What is the loan’s interest rate — in other words, how quickly will it accumulate interest? Is this interest rate fixed or variable?
- How much money will you pay each month once repayment starts, given a typical repayment plan?
- How much money will you be expected to pay in total, including interest, given a typical repayment plan?
- When does repayment start — after graduation, after a grace period, or immediately?
- Are educational deferments available if you attend graduate or professional school, and what are their conditions?
- Are different payment plans available, such as graduated or income-based repayment plans?
- Will your parents or other relatives be required to cosign your loan, and are they able and/or willing to do so?
Just like anything else, taking out student loans has pros and cons, and a variety of different loan options may be available to you with different risk-benefit profiles. Borrowing money to help pay for your education can help make achieving your goals more possible, but it’s up to you to get informed so that you can make the wisest possible choices about whether or which student loans are right for you.
For More Information
Finding a way to pay for college isn’t always easy, but the rewards are great, so it’s worth your time to explore all the options that exist for funding your college education.
Here are a few resources for learning more about financial aid, filling out the FAFSA, and making college more affordable:
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