If you’ve been reading through these blogs, I’m sure that by now you are sick and tired of hearing about student loans. If that’s what you are thinking, then too bad, because I’m going to be writing about student loans again. In this post, I’m going to be taking a look at the different types of student loans available.
The first distinction among loans that we will look at is federal loans and private loans.
Federal loans are loans that are offered and funded by the federal government. Private loans are any loans through an institution that is not the federal government. This could be a bank, a credit union, or some other sort of non-federal agency.
Let’s do a quick comparison of federal and private loans. Federal loans have a fixed interest rate that is set by Congress. The interest rate for a private loan is set by the lender. The interest rates for a private loan can be variable, meaning the interest rate could rise. While you are still in school, you do not have to pay interest on your federal student loans. Federal loans also offer several different repayment plans, have no prepayment penalty, and can qualify for a forgiveness program if you work in public service. This is guaranteed for federal loans. For private loans, it depends on the contract drawn up by the lender, and many times these advantages are not included in private loans.
Private loans also tend to be more expensive than federal loans. The interest rate for a federal direct subsidized loan is 4.29%. If you are looking at taking out a private loan, make sure it has an interest rate lower than the federal standard. However, keep in mind that the interest rate on private loans can change. When offered a private loan, check the contract to see if the interest rate is variable or fixed. Some companies will offer you a lower starting interest rate to lure you in, then raise the interest rate in subsequent rules. As a rule of thumb, it is best to avoid private loans, and if you must take out loans, take out federal loans.
Let’s focus more on federal loans and the different types of federal student loans a person can take.
The first type is a direct subsidized loan. A direct subsidized loan has a fixed interest rate of 4.29%. The interest that accrues while you are in college (enrolled at least half-time) is paid by the federal government. However, once the grace period is over, you will have to pay the interest yourself. Another way to think of it is that when you begin repayment of the loan, the amount of your loan to pay back will still be the principal. In order to qualify for a direct subsidized loan, you have to demonstrate financial need. A disadvantage to this type of loan is that there is a small fee (around 1%) charged for taking out the loan.
The second type is a direct unsubsidized loan. Everything here is the same as above except for two things. First, the government does not pay interest that accrues while the student is enrolled at college. However, that does not mean you have to pay the interest while you are in college. You can choose to hold off paying the interest penalty-free until the grace period for the loan is up. If you choose to do so, then the amount of the loan at the end of the grace period will be the principal plus any accumulated interest. Secondly, financial need does not need to be demonstrated in order to qualify a direct subsidized loan, anyone can receive one.
The next type of federal loan is a Perkins loan. A Perkins Loan is similar to a direct subsidized loan, in that the interest is paid for you while you are in school. However, the interest rate for a Perkins loan is higher, currently fixed at 5%. On the other hand, there is no fee charged when you take out the loan. In order to qualify for a Perkins Loan, a student will have to demonstrate significant financial need, greater than what is needed for a direct subsidized loan. A final difference is that the lender for the Perkins Loan is your school, whereas for other types of federal student the lender is the federal government’s Department of Education.
The last type of federal loan is a direct PLUS loan. This type of loan would not be taken out by a student, but by their parents. It is intended for parents who are paying for a dependent child’s education. direct PLUS loans have a higher interest rate, fixed at 6.84%, and a high loan fee, 4.272%. A direct PLUS loan is like an unsubsidized loan in that interest is not covered by the government while the student is in school.
This has been a lot of information, but from this I think we can draw a couple helpful points.
First, avoid private loans and stick with federal loans (unless you find an amazing deal even after reading through the fine print).
Second, subsidized loans are much better than unsubsidized loans. For subsidized loans, the government will pay your interest payments for you while you are in college. For unsubsidized loans, while you can defer payment of interest while in college, you will have to pay that money eventually.
One of the reasons many people fall into serious financial trouble with their student loans is that they don’t understand the provisions of the different loans they take. Many people find themselves in unfavorable contracts with private lenders, or took out unsubsidized federal loans not realizing that interest would still accrue while they are in school. Hopefully this post will help you to be smarter about what loans you take.
But what about the people who are struggling to repay their loans? What happens when the burden of loan payments is too much and you can’t feasibly meet your minimum payments anymore? The consequences of failing to meet your loan payments will be covered in my next post.