In this blog article, we discuss the pros and cons of college loans and offer three tips for making an informed decision for your future.
High schools nationwide have started placing a growing emphasis on the importance of a college education, and rightfully so. While we often hear inspiring stories of people who chose not to pursue a post-secondary education, we must realize that the probability of this happening to you is minute.
The truth is that college provides benefits, such as preparation for the workforce, networking, career services, and an increased earning potential. Moreover, it is unrealistic for high school students to know who they are or where they want to go with their lives right after high school, and college allows people to expand their horizons, develop their identity, and choose their path.
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The High Cost of College Loans
However, attending college is not an easy decision, especially for people living in the United States as forty-five million people have student loan debt. Taking out student loans is an unquestioned process in our society, but do teenagers know what it means when they sign on the dotted line?
The average student loan takes 21 years to pay off, which means that graduates fresh out of college already have a bill to pay off. Besides the obvious implication of having less disposable income, people must take safe jobs that deliver a stable income over a job with more opportunities for career growth in the future but with less money in the present. Furthermore, repaying a loan as soon as possible is in the borrower’s best interest to limit the interest accrued.
Making matters worse, the consequences of being in debt do not resonate with the majority of 17- and 18-year-olds. Moreover, deciding what constitutes a safe amount of debt is almost impossible because of a changing job market and the fact that one-third of college students change their major at least once, and another 10% change it at least twice (U.S. Department of Education). Regardless of your circumstances, if you are taking out any amount of college loans, it is essential to know these tips:
#1: Fill Out the FAFSA
There are two types of college loans – federal student loans and private student loans – and the type you end up with will significantly impact the amount people pay back. Federal student loans have fixed interest rates determined by federal law and are therefore not reliant on credit.
Moreover, their interest is usually lower than their private student loan counterparts. The FAFSA (Free Application for Federal Student Aid) is a requirement to access these federal loans. Students would want as low an interest rate as possible, so fill out the FAFSA. There are four types of federal loan options:
Direct Subsidized Loans:
Direct subsidized loans are available to undergraduate students who demonstrate financial need.
The amount a person can borrow depends on their financial need, determined by their school. The best part of direct subsidized loans is that the interest accrued while in school for at least half-time, the first six months after school, and during a deferment will be paid by the U.S. Department of Education.
A deferment means there is a postponement of the loan payments, and a person may acquire this if they face circumstances ranging from cancer treatment to unemployment to military service. However, each of these deferment programs has specific eligibility requirements and forms. If a person defers with a direct subsidized loan, they will not have to pay any accrued interest during this period if they have a direct subsidized loan.
Direct Unsubsidized Loans:
Direct unsubsidized college loans are available to undergraduate, graduate, and professional students regardless of financial need. However, as the name implies, interest will accrue during all periods because this type of loan is unsubsidized. The amount a person can borrow depends on their cost of attendance and other financial aid received.
Even though interest is accruing, a person taking out a direct unsubsidized loan will not have to make payments during particular periods, such as when they are in school or on another type of deferment. Despite a school being responsible for determining the actual loan amount a person is eligible for, there are still annual and aggregate loan limits.
These limits cap the amount a person can withdraw in a particular year and the total amount over undergraduate and graduate studies. Moreover, these limits apply to both subsidized and unsubsidized loans and vary based on how close a person is to graduation and whether they are an independent or dependent student.
Direct PLUS Loans:
Direct PLUS loans allow a person to fill the gap between the cost of attendance and the amount of money they have, plus direct subsidized and unsubsidized loans. However, unlike the previous two loans, direct PLUS loans require a credit check. There are two types of PLUS loans: parent PLUS loans and grad PLUS loans.
In both cases, interest accrues while a student is in school or during a deferment like a direct unsubsidized loan. With an adverse credit history, eligibility for a parent PLUS loan is still possible if there is an endorser or if documentation can be provided to the U.S. Department of Education proving extenuating circumstances that negatively affected credit history.
The endorser must not have an adverse history and should be willing to repay the parent PLUS if not repaid. Ultimately, the parent is legally responsible for paying off the parent PLUS loan, and the responsibility cannot be transferred to the child. Grad PLUS loans are for graduate or professional students enrolled at least half-time at an eligible school. The primary difference between the parent PLUS loan and the grad PLUS loan is that the student is legally responsible for the grad PLUS loan rather than the parent in the parent PLUS loan.
Direct Consolidation Loans:
Direct Consolidation Loans enable a person to consolidate multiple federal college loans into a new Direct Consolidation Loan to lower monthly payments and have access to federal forgiveness plans.
The types of federal loans may seem overwhelming, but the general wisdom is to maximize the direct subsidized loans to minimize interest and then follow up with direct unsubsidized loans and PLUS loans if there still is a funding gap.
#2: Understand Federal Repayment Terms
Federal student loans are much friendlier to the borrower than one may think. Firstly, they offer a six-month grace period, meaning people do not have to start paying their loans back until six months after graduation.
Furthermore, people have multiple options for repayment plans. They can choose a standard repayment plan (repayment within ten years of graduation) or an income-driven approach. An income-driven repayment plan ties a person’s monthly bill directly to discretionary income. There are four types of income-driven repayment plans:
- Income-based repayment. In this plan, the monthly payment will be 10% to 15% of a person’s discretionary income, and if the loan is not paid off in 20 or 25 years, the remaining balance will be forgiven. The exact terms of this plan depend on when a person took out the loan.
- Income-contingent repayment. This plan has the payment set to be 20% of discretionary income or the amount one would pay in a fixed payment plan over 12 years. If there is an outstanding balance after 25 years, it will be forgiven.
- Pay As You Earn. This plan has the payment set to be 10% of discretionary income, and it will never be more than the standard repayment plan. If there is a remaining balance after 20 years, it will be forgiven.
- Revised Pay as You Earn. This is the only plan without an income requirement, and a person’s monthly payment will be 10% of their discretionary income. However, there is no guarantee that they will pay less than a standard repayment plan. Any balance after 20 or 25 years will be forgiven.
Despite the appeal of these income-driven repayment plans, it is essential to realize that paying off a student loan as fast as possible will minimize the interest accrued.
#3: Shop Around for Private College Loans
Unlike federal loans – which have fixed interest rates and maximum loan amounts – private student loans have their standards. A good or excellent credit (usually 670 or higher) will likely get a person the most competitive rates and terms. However, since credit is involved, it is difficult for undergraduate students to qualify for a loan independently.
Most students who take out private student loans have a co-signer, such as a parent willing to take on the loan if the student does not repay it. Even if you have a great credit score, learn the rates of many lenders to ensure you have favorable terms.
However, federal student loans are usually the best because they offer income-driven repayment plans, forgiveness if you work in public service, and generous postponement in the case of financial hardship. Therefore, you should only turn to private lenders after maxing out federal loans.
For more personal finance tips, visit our Teenage Financial Insights blog.