Understanding how student loans work is essential for making decisions about for financing your college education and determining your financial future after you graduate.
Applying for free money to attend college – grants and scholarships – is always the best bet. Unfortunately, many students also have to take out loans to make ends meet. Two loan options are available:
- Federal student loans: These include Perkins Loans, which are awarded by the school and based on demonstrated financial need. Schools have a limited allocation of Perkins Loans with five percent interest rates. Direct Loans are more widely available and can be based on demonstrated need (subsidized loan) or available whether you demonstrate need or not (unsubsidized loan). Parent PLUS and Graduate PLUS loans are also available. Through June 30, 2015, new Direct Loans for undergraduates have a fixed interest rate of 4.66 percent, for graduate students, 6.21 percent and for PLUS loans, 7.21 percent.
Note: "Demonstrated need" is calculated based on the information you (and your parents, if you're a dependent) submit on the Free Application for Federal Student Aid (FAFSA). While you are in school, the federal government pays the loan interest for "subsidized loans" but not for "unsubsidized loans." You must either pay the interest as it accrues or it is added to your loan principal. More detailed information is available on the Federal Student Aid website.
- Private student loans: These loans are available from state loan agencies, traditional banks, credit unions and other financial entities. Private loans have a wide variety of variable and fixed interest rates that can range from 3.17 percent to 12.99 percent so it pays to "shop around." For a list of private education lenders, visit FinAid, a public service, student aid information website.
Federal or Private Student Loan?
So now that you know more about how student loans work, how do you decide whether to apply for federal loans or private loans or both?
5 good reasons to apply for a federal loan
- No origination or prepayment fees.
- Variety of repayment plans based on your financial situation and the option to switch plans if your financial circumstances change.
- Can consolidate multiple loans with multiple monthly payments into one loan with one payment. Interest on the consolidation loan is a weighted average of the interest rates of all loans included rather than a flat, predetermined rate.
- May be able to have some or all of your loans canceled or forgiven.
- May be eligible for forbearance and deferment options if you run into temporary financial difficulty and cannot make monthly payments.
5 good reasons to apply for a private student loan
- You need more funding to pay your college expenses than you can receive from financial aid scholarships, grants and federal loan programs.
- You have excellent credit and an ongoing relationship with your bank, which can result in being offered lower or discounted interest rates.
- You aren't eligible for any federal loan cancellation or forgiveness options.
- You don't anticipate that you will need the flexibility of loan deferment or forbearance due to temporary financial difficulty.
- A variety of fixed and variable interest rates are available, depending on the lender, and you can shop around for the best deal.
The decision to apply for a loan is an important one that can significantly impact your financial future. It makes sense to learn as much as you can about how student loans work – whether federal loans or private loans – and weigh all options available to you before making your final decision.