Guide to Student Loans

PayForED has created this student loan guide to help families better understand some of the student loan types, terms, and issues encountered during the college funding process.  This student loan guide also includes some current statistics on student loan debt and some basics on how these debts are affecting our future financial situations. 

As more and more families need to finance a large part of college education, understanding the options and creating the proper strategy can save you thousands of dollars.  Borrowers need to realize that their student debt structure will determine their repayment options.  The following will explain the types of loans available and their advantages and disadvantages. Further resources can be found in the ultimate guide to paying for college.

Student Loan Overview

Many families will need to supplement the cost of paying for college with a student loan.  It is overwhelming when we see that Americans today owe over $1.5 trillion dollars in student loan debt.  With that in mind, every borrower should have a basic knowledge of the various types of student loans available. The first step to take is to fill out a FAFSA. Many people wonder what is FAFSA?

Simply put, this is the form families submit to apply for federal financial aid. It is used by the federal government, states, and colleges to award grants, work-study programs, and loans. If a family completes the FAFSA, they become eligible for federal loans.  Federal loans give the borrower more flexibility as there are various repayment methods available.

There are several types of student loans available. We’ll go into more detail below but here are the basic types of loans available:

  • Federal Direct Loan (subsidized or unsubsidized)
  • Private Loans
  • Alternative Personal Loans (home equity or retirement savings plans)

We also want to get a high-level idea of how student debt is affecting the nation. Let’s look at some student debt facts:

  • Over $1.5 trillion in total U.S. student loan debt
  • Over 44 million Americans with student loan debt
  • 70% people in graduate with student debt
  • Average 2017 graduate has 37K in student debt and increasing

Federal Student Loans

Here we will detail federal student loan requirements as well as the various types of federal student loans.

Federal loan eligibility requirements:

Federal Student loans require the borrowers to be U.S. citizens or permanent residents enrolled at least half time in a qualified program at a participating school, not in default on a prior federal student loan, and not previously convicted of a drug offense while receiving federal financial aid. Total aid, including student loans, cannot exceed the school’s total cost of attendance (tuition and fees, room and board, transportation, personal and miscellaneous expenses). Most importantly, a FAFSA is required to be submitted each year for eligibility.

Direct Federal Subsidized Loans

Federal Direct Subsidized loans are offered by the government to help students pay for an associates degree, undergraduate degree, community college, trade, career and technical schools.  The loans are based on the student’s financial need after completing the FAFSA.  The amount you receive can’t exceed your financial need.  The U.S. Department of Education will pay the interest on a Direct Subsidized loan while the student is in college and repayment will begin six months after the borrower leaves school.  Direct Subsidized Loans issued after 7/1/2012 and before 7/1/2014 will have the interest charged one month after the student graduates or stop going to school.

There are benefits to a Federal Direct Subsidized loan.  The loan will retain its interest subsidized status while the student is in school and in some loan repayment methods.  This would include undergraduate and graduate studies.  An added benefit is that this loan is the legal responsibility of the student.   A parent does not need to co-sign for this loan.

Federal Direct Unsubsidized Loans

These loans are offered by the government to help students pay for an associates degree, undergraduate degree, community college, trade, career, and technical schools.  These loans are not based on the student’s financial need but to qualify you still need to submit the current year FAFSA form.  This loan is the legal responsibility of the student and not the parent. The interest on a Direct Unsubsidized loan will be charged interest while the borrower is in college and repayment.  During the six months grace period, interest will be charged, yet the borrower can defer payment while enrolled in a qualified program.

Parent PLUS Loan

These loans are federal unsubsidized loans funded through the federal government and given to parents of students to pay for college.  There is interest charged to this loan while the student is in school, and parents are legally responsible for repayment. These loans are not dependent on a student’s financial need but to qualify for this loan, the student and parent must complete the FAFSA form based on the tax-filing status.  

The Parent PLUS loan is not guaranteed but does have a lower FICO score requirements than a private loan.  There are Parent PLUS loan limits based on the student’s financial aid award.  If the parent is denied a Parent PLUS loan the student will qualify for an additional Direct Unsubsidized Loans depending on their academic progress.

The responsibility to repay the Parent Direct PLUS loan is the parent of the student and not the student.  Many parents may take this loan out with the intention of the student repaying this loan. Please never lose sight that it is in the parent’s name and ultimately the parent’s legal responsibility.  It will appear on the parent’s credit report and default will impact their credit score.

Parent PLUS loans are eligible for Public Service Loan Forgiveness if the parent’s job fits the PSLF’s eligibility.  The parent must use the income-contingent repayment (ICR) method of repayment and follow the stated PSLF requirements.   The Parent PLUS Loans must be included in a Federal Direct Consolidation Loan and the borrower must have entered repayment on or after July 1, 2007.   

Advantages & Disadvantages of Federal Loans

The advantage to the federal loans is that they have a built-in life and disability clause.  They also have better loan repayment and forgiveness options than what private loans offer.  Depending on the type of loan, the credit requirements are more favorable. The interest rates are set each year for all borrowers which can be another major advantage.

The disadvantages of federal loans are that they have limits per year and in total depending on the type.  For Parent PLUS and Grad PLUS the administrative fees can be expensive compared to private loans.

Listed below is the federal loan limit per year:

Dependent undergraduates (most students under the age of 24):

  • $5,500 as freshmen (including up to $3,500 subsidized)
  • $6,500 as sophomores (including up to $4,500 subsidized)
  • $7,500 as juniors and seniors (including up to $5,500 subsidized).

*The aggregate loan limit for the dependent student is $31,000.

Independent undergraduates (students age 24 or older) and dependent students whose parents are unable to obtain PLUS Loans:

  • $9,500 as freshmen (including up to $3,500 subsidized)
  • $10,500 as sophomores (including up to $4,500 subsidized)
  • $12,500 as juniors and seniors (including up to $5,500 subsidized)

*The aggregate loan limits for the independent undergraduates and dependent students whose parents are unable to obtain PLUS Loans is $57,500.  

Interest rate & Loan Limits for Federal Loans

Both the Direct Subsidized loan and the Federal Direct Unsubsidized Loan have a fixed interest rate that will change 7/1 of each year and is based on the May Treasury note auction plus the Department of Education add-on fees.  The revised rates impact direct subsidized, direct unsubsidized and direct plus loans. These interest rates are fixed for the life of the loan based on the type of loan borrowed.  

This is why a student may have different interest rates depending on the types of loans taken out each year.  And recently, student loan interest rates are on the rise! This can be very confusing to the borrower at graduation and is one reason for a federal consolidation could be a good option.

The rate will change if the loans are consolidated.  It will take the weighted average of each loan and the associated interest rate to establish the new direct student loan interest rate.

The following table provides the interest effective for new Direct Loans disbursed starting July 1, 2018, and before June 30, 2019.  The federal loan fees are also identified.

Private Student Loans

Private loans are often considered when federal loans are not enough to cover the cost of a college education.  A private student loan is a loan obtained through a bank or other financial institution. You can easily find a list of top private student loans lenders in 2019 to make comparisons. These loans are normally limited by some approval based on the financial award from the college. 

Most private student loans are limited to the cost of attendance less any financial aid the student has received as stated in the student’s award letter.  The student can take the loan out in their name but it usually requires a cosigner in case of default.  The interest rate is based on the borrower’s and/or cosigner’s credit rating.  The interest rates are normally variable but fixed rates are available.  The fixed rates are normally higher. 

A disadvantage to private loans is that they do not have the same repayment or loan forgiveness options as federal government loans.  Also, the co-signer needs to fully understand the financial risk they are taking on when signing for these loans.  It is recommended that life insurance and a disability policy be considered on the student who the loan is for. 

For co-signers these loans will appear on your credit report and if the primary borrower is late or defaults these issues will appear on the co-signers credit report.

Some private loans do offer a death and disability benefit but that is not offered by all lenders.  The co-sign can be released after some period of on-time repayment.  This will require the co-signer to ask for this release and it is not guaranteed.  It is important to search for these features. Borrowers and co-signers need to do your research before taking on this debt.

Federal Graduate School Loans

The same benefits are available for students moving onto graduate school if federal loans are used.  All the federal graduate loans are unsubsidized, so interest will be charged once the loan is distributed.  The biggest difference between undergraduate and graduate loans are the interest rates and fees are much higher for graduate school loans.  As we discussed earlier, this is where the proper planning comes into effect since the debt structure will dictate your repayment and forgiveness options.

Alternative Personal Loans for College

In addition to the typical educational financing options, there are other funding solutions to consider. As with any financing decision, you need to understand the risks and benefits of each option. This area of the college-funding decision cannot be answered by the college financial aid offices. These options fall into an area of personal financial planning that legally they cannot address by the financial aid office.

Here is a list of possible other options to consider:

  • Home Equity Loan or Line of Credit
  • Retirement Plan Loans
  • Home Refinancing

Importance of Projecting Your Total Student Loans

To prevent excessive student loans, students need to properly plan.  The ultimate guide to paying for college offers information in order to solve some of the issues projecting the total net cost and debt from the current process.  Families need an easy way to calculate the four-year net cost of college and the associated debt to attain that goal.  The colleges only provide a one-year estimation of the cost which does not help families properly plan. We are seeing the consequence of the current process as student debt is the second largest form of personal loans that the US consumer has.

Creating a four-year cash flow identifies when additional resources will be required to attend that college. Having this analysis, will enable the family to better plan their debt structure and make better borrowing decisions.  This means taking into consideration the various loan options and reviewing their advantages and disadvantages.

With this cash-flow concept in mind, taking the Student Direct loans (formally called Stafford) early in the college-funding process is recommended no matter what the family’s financial strength is. This concept goes against the conventional thought process since most times you want to delay borrowing the money for as long as possible. However, if the student borrows the money at the very beginning, parents will minimize the amount of debt in their names at graduation. In addition, the student loan interest rate is lower and the loan repayment options are better for the student rather than for the parents.

By understanding how the debt will be structured, you can project what your monthly payment will be at graduation. If you are able to do this during your college experience, our four-year methodology will improve your decision-making process and improve the student chances of financial independence.