How Student Loans Work

In my last post, we looked at the different elements that make up a student loan. Today, we’re going to look at a student loan in action. We’re going to create a hypothetical example to see how these different elements work together.

Meet Billy. Billy is a recent high school graduate who will be attending Kent State University. In order to fund his education, Billy takes out a $10,000 loan with a 4% interest rate to help pay for college. $10,000 would be the principal and 4% is the interest rate. Interest would not accrue on the principal amount until after the grace period (which is defined in the loan contract).

After the grace period, interest starts to accrue and Billy has to pay back the loan. Billy’s interest is calculated monthly. So every month, interest is added to Billy’s principal at a rate of (4%/12). On the first month, Billy would have $33.33 of interest accumulated. If Billy were to make a payment of $100 on his loan, that $100 would first be applied to the interest. After paying off the $33.33 of interest, the remaining $66.67 is out towards repayment of the principal. After that payment, Billy now only has a principal of $9,933.33 left.

For the next month, the interest would be calculated on Billy’s principal balance, which is $9,933.33. So at a rate of (4/12%), Billy would have $33.11 due in interest. If he makes another monthly payment of $100, he would pay off the interest of $33.11 first and the remaining $66.89 would be applied to the principal, reducing it to $9,866.44. This will continue until Billy has fully paid off the principal of the loan.

Under this payment plan of $100 a month, it would take Billy just over 10 years to repay his student loans (10 years and 2 months to be exact). Billy would also have paid a total of $2,187.20 in interest. This is where the true cost of student loans is revealed. This $10,000 loan that Billy took out might look like it only costs $10,000, but it actually costs $12,187.20!

But that was just for our example. As I mentioned in my first post, the average student loan debt for a graduate of Kent State University was $31,543. The interest rate set for direct subsidized loans (we’ll discuss what those terms mean in a later post) is 4.29%. Let’s stick with a loan term of 10 years, which is the standard for repayment.

Using these figures, our “average” calculation spits out a monthly payment of $323.72. At the end of 10 years when the loan is paid off, that person will have paid an additional $7,303.76 for interest.

As you can see, the interest on a loan makes a huge difference. When looking at taking out loans, you need to factor in the total amount of the loan that includes interest, not just the principal. Our friend Billy might have thought he only had $10,000 in loans, but in reality he had to pay back much more than that!

Another interesting thing of note is that when you make a payment on a student loan, the payment is applied to the interest first, then any remaining money is applied to the principal. When talking to people about their student loans, this was something a lot of people expressed surprise about. But it’s an important fact to consider – you may make a $500 payment for your loans, but your principal will not decrease by $500. It will only decrease by whatever is left of that $500 after interest is paid. So, the more interest that accrues on an account, the harder it is to pay off the principal of the loan.

The effect of interest on student loans is not to be underestimated. The more interest that accrues on your account, the more money you will have to pay, and the longer it will take to pay back your loans. As I mentioned before, look at the interest rate and it’s projected effect when taking loans in order to get an accurate look at what your amount you will eventually have to pay back.

If there’s one thing that you’ll hopefully walk away from this with, it is that the amount of loans you take out is not the amount you will pay back. You will pay back much more. Think realistically about your loans, think of them in the amount that you will have to pay, not the amount that you received.

Here is a link to a useful loan calculator. Plug in the information for your student loans – what you find might be a little bit surprising, and maybe even a little bit scary. Maybe it will motivate you to think differently about your loans.

Well, that is all I am going to write for today. Next up on the schedule will be a comparison of the different types of student loans you can take.

Elements of a Student Loan

In my first post, I discussed some of the consequences to carrying a large student debt. How there are spiritual consequences in addition to financial consequences. Hopefully the post made you think more about your situation in regards to student loans.

One thing I have found when talking to people is that they don’t really understand their loans and how they work. It seems as though many are content with taking whatever loans are offered to them and leaving it at that. Here is an article that touches a bit on the fact that many students don’t understand what they are getting into when they take out student loans. This lack of understanding is a main factor when people struggle later in life to pay back their student loans.

The goal of this post is to educate people on some of the basics of their student loans. My hope is that with a better understanding of student loans, people can make better decisions in regards to them.

First, we’re going to take a look at the different elements that make up a student loan to help us get a better understanding of the concept. There are 5 elements that we will be covering; principal, interest, interest rate, term, and repayment.

Principal. The principal is the amount of the loan that you took out. Essentially, it is the money you borrow and receive from a lender. So if you took out a $10,000 student loan, that $10,000 would be the principal.

Interest. Interest is the amount that you are charged for taking out the loan, in addition to the repayment of the principal. Interest is how lenders make money on loans. Interest is calculated using an interest rate (explained below). Most loans have a grace period, where interest is not charged. This grace period usually lasts until 6 months after a student graduates or leaves school, but it varies by loan.

Interest Rate. The interest rate is the percentage charged to the principal to determine the interest. Interest rates are displayed by their APR (annual percentage rate). However, interest is calculated in many different ways, such as annual, monthly, daily, or even continuously.

Term. The term is the amount of time the loan is for. So if you have a loan that you have to pay back in ten years, the term would be ten. However, for student loans this is not usually fixed – the term will be dictated by your minimum payment, but you can decrease the time of the loan by increasing your payments.

Repayment. Repayment is the paying back of the loan. Repayment starts when the grace period ends. Most loans usually require you to make a monthly repayment. There will be a minimum monthly repayment on the loan, however you can pay back more than the minimum if you want. You can also pay back less, however, this will cause you to be charged fees, and if you fail to meet the monthly payment for several months your loans could enter default.

So there we have it – principal, interest, interest rate, term, and repayment. I’m going to stop here for today. This part is getting a bit technical, so I don’t want to overwhelm anyone as they read this.

For the next post, I’m going to create an example of how these different elements work together. In this example, I think we will also see some of the hidden costs of student loans that people don’t see until it’s too late.

The Consequences of Student Loans

About a month ago I came across an article online titled This is Why Millennials Will Never Grow Up. At first glance, I thought it was going to be some dumb article where the author makes fun of millennials for living in their parents’ basements, or something along those lines. However, as I read the article I found that my presumption was quite wrong. The author highlights a real problem facing people of my generation.

Here’s the article if you would like to give it a read: http://www.marketwatch.com/story/this-is-why-millennials-will-never-grow-up-2015-08-05.

If you don’t want to read the article, let me give you a summary, or as us millennials say, a TL:DR – high student loan debt is forcing many millennials to delay important life events, such as marriage, having kids, buying a home, or buying a car.

Student loan debt is something that has been on my mind a lot. About a year ago, Tom Smith and I were working on a blog that would be about the problem of student loans. The blog got stuck in the proofreading stage, and never came to be. Following the old saying “better late than never,” I decided to rehash some of what we had written and present it in this blog post.

It’s an opportune time to talk about student loans. School is back in session, and on college campuses worldwide, millions of new students are eagerly starting their college career. Many of them will graduate four, five, or six years later, proudly showing off their hard-earned degrees. Unfortunately, many of them will also graduate with a crippling student debt that will continue to have an impact on them years down the line. 79% of graduates in 2013 had student debt. That’s nearly 4 out of every 5 people. The average debt among those 4 was $30,996. Since most of the people reading this are Ohioans, let me bring these numbers a little closer to home. In 2013, 76% of graduates from Kent State University graduated with some sort of student loan debt. The average amount of debt among those graduates was $31,543. The University of Akron, the other Xenos college of choice, clocked in a bit better, with only 72% of graduates having student loan debt and the average amount being only $23,791.

Imagine graduating college, ready to start your adult life, and already being weighed down by $30,000 in debt. Research has shown that for someone with a bachelor’s degree, it will take them 21 years to pay back their loans. Are you okay with losing a part of your income each month for 21 years because of your student loans? What would you have to sacrifice because of these payments? According to the article I started this blog off with, many millennials have had to sacrifice buying a car, buying a home, getting married, or having children because of their loans. Do you really want to be in a similar situation?

Now, I think we can all agree that student loans are bad from a financial standpoint. But I want to go a bit further and bring a spiritual aspect into the conversation. The Bible teaches that the world is under the control of the evil one (1 John 5:19), and Satan has set up an elaborate system to trap and enslave people, known as the “kosmos.” 1 Peter 5:8 says that Satan “…prowls around like a roaring lion, seeking someone to devour.”

Am I saying that student loans are satanic? No… but it definitely fits in his system. Isn’t the following what has happened to a generation of young people?

If you want to get a good job, you need to go to college!

In order to pay for college, you need to take out all these loans!

Now that you’ve graduated, you need to get a job so you can pay back your loans!

Does anyone see anything wrong with this situation? Take out loans to go to college, so you can get a good job so you can pay back the loans you took out to go to college in the first place!

Now, I am probably oversimplifying things and being a bit too harsh. Student loans can give people the opportunity to go to college who couldn’t otherwise afford it. They can be an investment in the future – you are taking out a loan now so that you can have a higher income later on in life.

But we need to understand that there are some serious consequences to carrying a large student loan debt. Going back to the original article I cited, one might have to delay important events in their life because they can’t afford it due to their debt. The events cited in the article were all important ones, but let’s take it a step farther. What if you were given the opportunity to go into the missions field, but had to turn it down because you were saddled with too much student debt? What if you wanted to go to seminary but couldn’t afford it with the monthly payments you were making towards your loans? Or, what if you wanted to be a part of a church plant in another city, but couldn’t risk the chance of not getting a new job right away because of your loan payments?

One could say “if God really wanted me to do these things, he can make it happen despite my student loans.” I do believe that is true for some situations, where God will take care of things so that you may take up these opportunities. However, we are called to be good stewards of our money, and it seems unreasonable to make poor financial decisions with the assumption that God will take care of everything later on. Wouldn’t that be kind of similar to saying “I won’t prepare for this teaching, because if I just rely on the Lord everything will work out?”
I’m not saying that student loans are inherently wrong, but that they can become not only a financial problem, but a spiritual problem as well, preventing us from taking part in some awesome opportunities made available to us.

One thing I have noticed in talking to people is that many don’t really seem to understand their loans, and what taking out student loans entails later on in life. It can be tough to look at the whole picture when the consequences of student loans won’t come into play until years down the line. I encourage everyone to think practically and seriously about this topic. I would hate to see someone miss out on an opportunity like mentioned above because of their debt.

Over the next couple of days, I will be releasing a few other blogs about student loans. The first will be more technical, giving a breakdown of how student loans actually work. It may be a tad boring, but doesn’t the saying go “know your adversary!” After that will come a post with practical advice on how to avoid loans, or how to minimize their impact if you already have them. I hope you will come back to read the other posts, and that you take this information to heart.

In the meantime, if you would like some further reading on student loans, here are some things you might find interesting:

http://www.forbes.com/sites/maggiemcgrath/2015/09/09/desperate-and-in-debt-30-of-millennials-would-sell-an-organ-to-get-rid-of-student-loans/. 30% of Millennials would sell an organ to get rid of their student debt!

http://www.neoblogs.org/tsmith/student-loans/. Here is a post Tom made about his student loans. It gives a more personal look into the subject, and he also shares some practical tips that helped him. FYI, Tom tweeted a couple weeks ago that he had finished paying off his student loans!

http://studentdebtcrisis.org. Just judging by the name of this site, you know it’s gonna be good! Keep yourself up late at night by reading the horror stories submitted by people about their student debt.

http://www.fastweb.com/financial-aid/articles/the-horrors-of-defaulting-on-education-debt. Some more horror stories, this time of people who couldn’t afford their loan payments and had to default on the debt.