Getting a degree is a costly process. However, there exist people who get money from outside sources to continue education. Family financing, scholarships, grants, or student loans exist to assist such people. Those who receive scholarships and grants are lucky because they are not required to return the money in most cases. Yet, those who receive student loans risk their finances as they take huge obligations-repaying the debt together with interest. Student loans can be unavoidable if other financing methods are not available. However, before you get a student loan, either federal or private, you have to understand every detail to minimize the mismanagement of the debt and learn how do student loans work.
You need to understand the importance of the debt obligations and develop a sound plan to return the debt. This guide aims to help people in need of student loans to finance their education. You will find much information regarding how do student loans work, their interest rates, the application process, different types, etc.
Before you decide on getting student loans, make sure that you understand the loan terms and how do college student loans work. Loan terms can involve technical elements that can be hard to understand for students and other borrowers. In that case, borrowers agree to the obligations without realizing the burden the debt will bring.
You can avoid this challenge by getting a third-party debt specialist’s help. Debt experts, like those in Student Loans Resolved, have the necessary background for debt management. They can analyze the loan terms and evaluate the fit of the debt to your finance.
In this way, you will ensure the easy repayment of the debt and avoid any future problems emerging due to student loan debt. Do not risk getting a loan without being fully informed, as debt repayment can last tens of years, and you will be stuck with the debt concerns for a long time.
Types of Student Loans
Student loans, regardless of type, aim to help students finance their education. There exist two main types of student loans, federal and private. Federal student loans are provided by the government and the Department of Education. Meanwhile, private lenders offer private student loans. Besides, you need to be aware of refinancing loans. Refinancing loans are used to pay out existing federal and private loans. We will explain each type in more detail.
How Do Student Loans Work? [Federal Loans]
The Education Department provides federal loans. These loans are usually called Direct loans, and they have four different types:
- Subsidized loan- if you are an undergraduate student, you can apply to this loan program. The applicants are selected based on financial needs.
- Unsubsidized loan- if you cannot demonstrate financial needs, you can apply to unsubsidized direct loans. This loan program does not consider how much the applicant needs the debt. It is available to undergraduate, graduate, and professional students.
- PLUS loans- for education costs that no other financial assistance programs cover, PLUS loans can be requested. Graduate or professional students and parents can be borrowers. However, reliable credit performance is required. When a loan is made to students, it is called a Graduate PLUS loan. When parents are borrowers, the loan becomes a Parent PLUS loan.
- Consolidation loan- as its name suggests, a consolidation loan combines different loans into one. As a result, the borrower deals with a single lender.
Once you get the loan, you will be required to start paying at some date. You will repay the original debt balance, plus any interest demanded.
Benefits of Federal Loans
Federal student loans deliver multiple benefits. Government usually considers the well-being of people rather than the profitability of programs. Hence, it is not surprising that the interest rates of federal student loans are usually lower than private student loans. Besides, such loans have fixed interest rates. It means the interest rate does not change over time.
These loans are mostly made to students who lack credit performance. Hence, most federal loans do not require high credit performance except Direct PLUS loans. After you receive the loan, you do not need to start repayment while studying or six months after graduation, called Grace Period.
Moreover, multiple repayment plans exist. Therefore, you can choose which plan fits your finances and conditions the best. Lastly, you can qualify for forgiveness and loan discharge programs to eliminate your debt obligations. For example, if you qualify for Public Service Loan Forgiveness, you can get rid of the debt in a minimum of ten years after making 120 payments.
How Does Interest in Student Loans Work?
The interest rate indicates how much money you will pay in addition to the borrowed amount. The lower the interest rate, the less you will repay. Although you do not need to repay the debt during studying or Grace Period, your interest payments can still accrue. Later, it can be added to your original debt balance. Such adding- capitalization- the process is not desirable. As interest payment is the percentage of the principal balance, if the principal balance increases, you will pay more.
Additionally, the government provides student loan forbearance options. This option helps borrowers who cannot repay the debt. As a result of forbearance, the debt is not collected for a few months. However, be aware that interest payments will still accumulate and add to the principal balance once the debt payment collection resumes.
Interest Rates for Different Federal Student Loans
The interest rate is generally lower for federal loans, but it depends on which Direct loan you choose. For example, Subsidized loans require, as of time, 2.75% interest. This rate is still the same for undergraduates requesting Unsubsidized loans.
However, for graduate and professional students in need of unsubsidized loans, the rate will jump to 4.30%. Yet, it is still lower than what PLUS loans require. The interest rate for PLUS loans, till July 1, 2021, is fixed at 5.30%.
Interest Non-Payment based on Loan Type
As mentioned before, some loans accrue interest during non-repayment periods, such as when you are still studying. If you get a Subsidized loan, such problems will not happen. While you are studying or during Grace Period, the Education Department will cover the interest payments. The interests will not be capitalized to your debt balance.
However, you are still responsible for paying the interest for Unsubsidized federal loans, whether you are in school or not. Similarly, for PLUS loan borrowers, the interest payment is necessary. If you do not want to pay interest during allowed periods, they will accumulate and become a part of the principal balance.
How Much Debt Can be Borrowed?
The answer to this question is the same as interest rates- your maximum debt limit will depend on which loan you want to receive. For Subsidized Loans, financial need is essential. Hence, the school determines the costs, but your debt amount might not be more than what you need financially.
In general, if you are an undergraduate student, the loan limit will be between $5,500 and $12,500 yearly. For graduate and professional students, this amount can increase to $20,500 per year. Lastly, PLUS loans cover the remaining debt that other financial tools do not cover. Hence, the monthly amount depends on how much money is needed in the first place. You can get more detailed information about what debt amount you qualify for on the official Student Aid website.
One of the greatest advantages of federal student loans is that they provide many repayment plans. As a result, borrowers can choose the most suitable option among different options. We will discuss each repayment plan quickly, but you can get more information by contacting us or reading Student Loans Resolved blogs.
Additionally, you can use the Loan Simulator tool in the Student Aid portal. This tool helps borrowers to determine the most affordable and easy repayment plan.
1. Standard Repayment
The name says a lot about this repayment option. Federal student loan borrowers get a fixed repayment through this plan to pay out the debt in 10 years. Almost all borrowers qualify for this program, including Subsidized, Unsubsidized, PLUS, and consolidated loans.
2. Graduated Repayment Plan
A graduated plan involves paying less during the first two years and getting higher payments in subsequent years. As a result, similar to the Standard plan, you will repay the debt in 10 years. The eligibility criteria are also the same as with the Standard plan- almost every federal loan borrower can choose this option. However, keep in mind that as the payback period is short- 10 years, the monthly payments can be high. If you need a more affordable plan, keep reading.
3. Extended Repayment Plan
This repayment plan helps borrowers to pay off the debt in 25 years. You can choose to make fixed payments as in the Standard plan, or pay less and then high- as in the Graduated plan. The plan involves all federal loan types, but your debt should be higher than $30,000.
4. Revised Pay As You Earn (REPAYE)
The following four repayment plans are categorized as Income-Driven repayment plans. These plans are based on income level and family size. If you earn less, you will pay less. Hence, they are the most affordable options. Besides, people who want to apply for a Public Service Loan Forgiveness can only repay the debt through income-driven repayment plans.
Revised Pay as You Earn (REPAYE) allows borrowers to pay the debt for 20 or 25 years. The shorter period is for undergraduate students. If you get debt for graduate or professional studies, you will qualify for 25-year repayment. Your monthly loan payment amount will be 10% of the discretionary income. Discretionary income is what is left after deducting necessary expenses and taxes from your income. Keep in mind that Stafford-type loans or Parent PLUS loans will not qualify for this plan.
Additionally, any debt left after 20-25 years of repayment will be forgiven. The forgiven debt is taxable. Lastly, your payment amount can be higher than what the Standard plan requires by time.
5. Pay as You Earn (PAYE)
Another Income-Driven repayment plan is Pay as You Earn. Similarly, the monthly amount depends on the income level and family size. The monthly payment is 10% of discretionary income. You will repay the debt in 20 years, and the remaining will be forgiven.
Different from REPAYE, the payment is never higher than the amount through the Standard repayment plan. Again, Parent PLUS loans and Stafford loans are not eligible. Besides, you need to be a new borrower after October 2007 and get your loan after October 2011 to get eligible.
6. Income-Based Repayment Plan
The conditions for this repayment plan change depending on when you got the loan. If you got a loan after July 2014, the repayment amount is 10% of discretionary income. For others, this rate increases to 15% of discretionary income.
Besides, borrowers (after 2014) repays the debt in 20 years, while for others, the repayment period is 25 years. Stafford loans, in addition to Direct Subsidized and Unsubsidized loans, can qualify for this repayment. However, Parent PLUS Loans will not be eligible.
7. Income- Contingent Repayment Plan
You might wonder then which Income-Driven plan involves Parent PLUS loans? It is the Income-Contingent plan, but parents should first consolidate their loans for this repayment option. The repayment amount is either 20% of discretionary income or enough to pay out the debt over 12 years. In general, 25 years of payback is required.
How are Federal Loans Forgiven?
The government provides many options to get rid of federal loans. Forgiveness and discharge programs exist for this purpose. Forgiveness is usually granted due to service, while discharge happens based on an existing external condition. In the following sections, we will explain each federal assistance option briefly, but you can get more information in our blogs.
1. Public Service Loan Forgiveness
Depending on which forgiveness option you choose, you can qualify up to 100% debt forgiveness. The Public Service Loan Forgiveness plan brings 100% debt elimination once the borrower makes 120 payments. However, the payment should be made on time, in full amount, and under Income-Driven plans.
Keep in mind that throughout the whole payment period, which is a minimum of 10 years, you need to work for a qualifying public organization such as a federal, local, tribal, and non-profit organization. Your position should be full-time, which is defined as a minimum of 30 hours per week. Working in multiple positions can make you qualified if you work part-time. Lastly, the forgiven debt is not taxable.
2. Teacher Loan Forgiveness
Teacher Loan Forgiveness, as the name suggests, benefits teachers working in low-income schools. Borrowers can either get $5,000 or $17,500 based on their qualifications. In return, applicants should serve for five years.
3. Perkins Loan Cancellation
If you have Perkins loans, which are not distributed anymore, you can apply to this program. Perkins Loan Cancellation grants different forgiveness percentages depending on the service year. For the first two years of service, you will receive a 15% discharge. For the following two years, you will get a 20% discharge. In the fifth year, 30% of the original debt balance is canceled. Nurses, teachers, firefighters, librarians, law enforcement, and others can apply to this program.
4. Borrower’s Defense to Repayment
This option helps borrowers whom schools misled. There have been cases when for-profit schools misled the borrowers- lied about job replacement rates, quality of education, or true education costs. In such cases, the borrowers can apply to Borrower’s Defense to Repayment to eliminate the debt. The main condition is proving that if the school did not engage in fraudulent activities, you would not choose that school. Hence, you need to have clear arguments and supporting documents as proofs.
5. Discharge Programs
Discharge programs can be accessible for several reasons- death, bankruptcy, total and permanent disability, school closure, etc. Death discharge can be applied if the proof of death of the borrower or a student for whom the Parent PLUS loan is taken dies.
In case of total and permanent disability, the borrower should get documentation from Veterans Affairs, Social Security Administration, or Physicians. Closed school discharge usually applies automatically, but you can also contact the loan servicer to request this discharge opportunity.
How Do Private Student Loans Work?
Another option for students is getting loans from private lenders. However, compared to federal loans, private loans have more drawbacks. Hence, it is usually advised to apply for federal loans first. If you cannot get any federal loan, you can look for affordable private student loans.
Mainly private loans work like federal loans- you get debt and repay it together with interest. The difference is in the process. Federal loans usually do not require a credit check.
However, for private loans, credit performance evaluation is almost always required. Some lenders allow borrowers to involve a cosigner if they cannot meet the eligibility conditions. For instance, if the borrower still studies, there is a low likelihood that he/she has a stable income or reliable credit history.
In such cases, family members can act like cosigners. Cosigners agree to repay the debt if the borrower fails to do so. Additionally, keep in mind that even if you need a private loan, try to get the minimum amount you need because it is costly to repay the debt.
The interest rate depends on the lender and the borrower’s qualifications. The borrowers who have better credit performance, good income, and cosigners are reliable. Hence, they can qualify to lower interest rates. In contrast, those who are young students with no employment usually qualify for higher interest rates.
College Ave is one of the most affordable private student loan providers. The minimum interest rate is 3.34% for fixed loans. Meanwhile, the interest for Ascent starts from 3.43%, for Sallie Mae from 4.25%, for SoFi from 4.23%, etc. You can check each lender to get familiar with the whole loan terms.
The repayment for private loans is not as flexible as the federal loans. You will usually have access to a few student loan repayment options. For example, best lenders provide interest-only or fixed payments during the student studies or several months after graduation.
Later, many lenders require both principal and interest payments. You will not also qualify for many forbearance or deferment options. Only a few lenders allow forbearance in case of economic challenges, but the period is usually less than the federal loans permit.
Can I Get Forgiveness for Private Loans?
The answer to this question is mainly – NO. Private lenders are interested in the profitability of their offerings. They do not like to provide favors to borrowers, neither are they obliged to do so. Hence, most of them do not allow forgiveness under any conditions. You can access death discharge or total and permanent disability discharge for your private loans in the best case.
Federal vs. Private Loans
You already have some idea about the differences between federal and private loans and how do student loans work. In this section, we will summarize these points. Private lenders offer private student loans while the government and Education Department provide federal student loans.
The interest rates and eligibility criteria are more favorable for borrowers in federal loans. Federal loans do not require a credit check in most cases, but it is a requirement for private loan borrowers. You can utilize forgiveness programs for federal student debt, but you cannot eliminate private student debt in most cases.
In general, your first destination for financing education should be federal loans. If you do not find a qualifying loan for your conditions, you can then apply for private loans.
How Does Refinancing Student Loans Work?
Student loan refinancing involves getting a new loan from a private loan to cover your existing loans. You might wonder why people get refinancing loans at all. Some borrowers struggle with their existing loan servicers, while others want to move to fixed-interest or variable-interest.
Besides, when the interest rates decline overall, the borrowers can qualify for lower loans. In all these cases, the borrowers can refinance. Getting a new loan allows changing the loan servicer, the structure of interest (fixed or variable), or qualifying for better loan terms. In this way, you can save money or simplify the debt repayment process.
Private lenders offer refinancing services. It is possible to refinance both federal and private loans. The lenders require stable income, reliable credit performance, and a cosigner. You can find options without a cosigner requirement if you have great credit performance. In general, a credit score of 600 or more is desirable. A cosigner should also meet these requirements of income and credit history.
Application takes only a few minutes through the online platforms of lenders. Before you submit the documents for the actual application, it is advisable to use a pre-application tool. This tool allows borrowers to submit documents and see if they qualify for the refinancing loan. If you get a rejection, your credit score can be affected negatively. Hence, pre-testing will help you avoid getting rejections.
Students might need funding sources for their educational goals. Scholarships or grants bring the money required and do not ask for repayment. However, they are not accessible to many students. Meanwhile, student loans can be accessible to larger student groups. Federal, private, and refinancing student loans can help you to afford education expenses.
This guide explained how do student loans work for each type of loan. We discussed the interest rates, application processes, forgiveness options, etc., to assist you in choosing the best option and learn how do student loans work. However, after reading the material, it is still required to collect in-detail information. If you want to avoid any mistakes, you can also get help from debt experts, like those in Student Loans Resolved. Our experts can analyze your needs and finances to develop a sound loan plan. In this way, you do not need to worry about challenging the repayment process. Call us now for a free consultation.