The total student loan debt in the United States has reached $1.6 trillion. Student loans are an integral part of launching your life as an adult, as they allow students to fund their academic exploration and earn degrees. In 2021, the Biden administration made it clear that they would like to change the student loan process entirely and forgive student loan debt. Though it is not clear what exact changes will be made, there will most likely be a new and more efficient student loan process set into place.
What are Student Loans?
Student loans financially assist students with paying for post-secondary school, on the basis that they will pay back the loan after graduating. The money loaned can be used to pay for tuition, living expenses, and supplies. The lender of the student loan can either be the government or a private lender.
There are two main types of student loans: federal student loans and private student loans. Federal loans are offered by the government and have congressionally set interest rates. Nearly anyone is allowed to apply for federal student loans, so long as they have a high school diploma, and repayment does not start until you graduate. Private loans are offered by private financial institutions. These loans are harder to attain compared with federal loans, as private lenders require proof of future repayment (e.g. credit score, income, and other factors).
Though student loans sound helpful, they can be quite a burden to pay off later in life. The average amount of student loan debt per debtor in 2020 was $37,584. The reason for this is primarily due to compounded interest. Loans with compounded interest annually increase the principle of the loan by adding the principle and the interest of the previous year. This way the lenders increase their return on the loan the longer the borrower does not pay it off.
Despite their long-term effects being strenuous, student loans are the reason many can afford a secondary education. A college degree is an essential aspect of any resume and a necessity for many job applications. Without student loans, 54% of Americans would not have been able to afford college.
How can you get a Student Loan?
When borrowing from the government to pay for college, you must submit a FAFSA application (free application for student aid). The form allows the government to determine how much of a loan you qualify for. Similarly, in the private lending sector, you must apply for a loan through a bank. The processes for both types are not too different, just that in the private sector it varies by bank.
In the public sector, the government requires student borrowers to do entrance counseling, as to inform the student what they are getting themselves into. Counseling sessions are around a half hour, and more information about it can be found through the student’s school.
Federal student loans offer the lowest interest rates and have the most flexible repayment plans. These loans are offered on a need basis. So applying for government loans should be the first step in the college financing process.
As dictated by the government, the student must additionally sign a Master Promissory Note (MPN) in order to borrow money. The MPN is signed by the student to signify that they will pay the loan and interest payments. Private lenders also have an agreement for students to sign, similar to MPN. Most student borrowers will require a cosigner to acquire a private loan.
Special Federal Student Loans
Undergraduate students are offered Direct Subsidized Loans based on their needs, determined by FAFSA. For Direct Subsidized Loans, the federal government makes interest payments on the behalf of the student while they are still in school. Once the student finishes school or drops out they have a 6-month period before loan repayments start and interest accrues.
Students who are not financially in need can apply for Direct Unsubsidized Loans, as they do not require a demonstration of financial need. Unsubsidized loans are open to both undergraduate and graduate students alike, though the government does not cover interest: consequently, interest continuously accumulates from the moment the loan is issued.
Additionally in the public sector, Direct PLUS Loans are offered. These loans allow parents to take out a student loan for their dependent, and graduate students can take out the loan for themselves. PLUS loans constitute an application process separate from the FAFSA application and require a credit history check.
Private Student Loans
Private student loans vary from bank to bank, and they are more expensive and have higher interest rates. Students must also make loan payments while still in school; the student will not have assistance from the government in making interest payments. Lenders have the ability to decide all of the loan factors and conditions.
Private student loans can be helpful as federal student loans are not offered to students who have graduated from graduate school in law or medicine and are studying for the bar exam or searching for a residency program. Private lenders offer specific loans such as Bar Study Loans, which cover bar exam fees, living expenses, and review courses for students studying for the test. Lenders also offer Residency and Relocation Loans, which allow medical and dental students to pay the fees in association with finding a residency program. Some fees this loan covers are interview travel expenses, relocation costs, and board exam expenses.
The amount of loan interest on any given loan is dependent on a few factors, including repayment term, interest rate, and principal. The repayment term is essentially the time you will take to pay off your loan. Federal loans usually have a 10-year term, though they can be as long as 30 years. For private loans, the agreement between the lender and the borrower dictates the term length, which again can vary.
The interest rate of the loan determines the amount of interest the student borrower will be paying as a result of the loan. For the most part, federal loans have a fixed rate, meaning interest is the same year to year, though the rate can vary by loan. Private interest rates, on the other hand, are usually calculated based on your credit rating and can be fixed or variable.
Loan principal is the amount of money the student has taken a loan on. This is obviously different in every case, but on average, it is around $35,000. With these 3 factors, interest can be calculated for a regular interest plan, where the total interest owed is found with this formula:
(term length)*(principal)*(interest rate)
- Standard: The lender creates a repayment schedule, including monthly payment amounts. Standard federal loans are repaid within 10 years, and standard private loans vary.
- Graduated: The payments gradually increase every couple of years, so that earlier on the borrower is taking on a lower amount of debt, while later in the repayment process the borrower takes on greater amounts of debt repayment. With these plans the loan is paid off within 10 years.
- Extended: The payment timeline is increased beyond 10 years, as to help borrowers who have already accumulated $30,000 in outstanding debt. Either a fixed or graduated payment schedule can be applied to this plan, and are paid off within 25 years.
- Income-Based: The payments are based on a percentage of the borrowers income. 10-15% of a borrower’s income, after taxes and living expenses, will be put towards repaying the loan. These payment amounts are recalculated annually and are adjusted for change in income and various other things.
- Income-Contingent: This payment is also based on percentage of income, though it is 20% of the students discretionary income (amount left after all expenses). Rates are adjusted annually, and the balance can be forgiven and taxed, over the course of 25 years.
Private loans are an agreement between the borrower and lender, so the lender sets the repayment rules. Commonly, the payments are monthly, and the borrower is paying a combination of both the interest and principal.
Though student loans can be difficult to understand and seem impossible to pay back, they provide a solution to the problem of students not being able to afford secondary-education. The system is pitted against the borrower and makes it challenging to leave the endless cycle of debt. Though, with proper planning and precautions, these obstacles can be avoided and leave the student with an overall good experience. It is also crucial to choose the correct loan plan that meets your needs and personally suits you. In the near future, we may see a drastic shift in the way the government meets the needs of those who require financial assistance to pay for their education, as to correct the flaws of the current system. This change may alleviate the struggles of student loans and repayment, and create a more borrower-friendly system. So be sure to look out for the latest updates on student loan policies, and meticulously plan when financing for college.