Types of Student Loans, Pros/Cons and How to Get One

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Higher education can be very expensive, especially in the United States. According to the Education Data Initiative, for 2023, the average cost of attendance at a 4-year in-state institution was $26,027 per year.

Many students can’t afford the high cost of tuition and other related expenses. Student loans help to cover these costs and enable students to complete their education.

What is a Student Loan?

A student loan is money you borrow from a financial institution or the government to pay for college or other higher education. Like any other loan: you must repay it, typically with interest over time.

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Types of Student Loans

Student loans are an investment for your future. You borrow money to pay for your college education in hopes that it will lead to good job opportunities and a stable income later. 

There are two main types of student loans: federal and private. Each has different options designed for different types of students, and each option comes with its own terms and conditions.

Federal Student Loans: 

Federal student loans are loans from the government. They usually have low fixed interest rates, meaning the rate doesn’t change over the loan’s lifetime, and they offer protections for borrowers. There are three main types of federal student loans:

  • Direct Subsidized Loans: These loans are available to undergraduate students who have shown they need financial help. The interest doesn’t accumulate while you’re in school or six months after leaving.
  • Direct Unsubsidized Loans: These are for undergraduates and graduates, and you don’t have to prove financial need to get one. But the interest starts adding up immediately, so you’ll owe more over time.
  • Direct PLUS Loans: These are for graduate students or parents of undergraduates. They have higher interest rates and fees than subsidized and unsubsidized loans. Parents take out these loans and are responsible for paying them back, even if the student helps make payments.

Private Student Loans: 

Private student loans are loans from private lenders, like banks. They might let you borrow more money than federal loans, and they might have lower interest rates if you (or a co-signer) have a good credit history. But they usually don’t offer as many protections or benefits as federal loans.

Private loans boil down into undergraduate and graduate loans:

  • Undergraduate Loans: These private loans usually require a co-signer, like a parent, who agrees to be responsible if you can’t pay the loan. These loans typically have higher interest rates than graduate student loans and lower limits on how much you can borrow.
  • Graduate Loans: These private loans are designed for students in graduate, law, medical, or business school. They often have higher limits, longer payback times, and lower rates than undergraduate loans. They might not require a co-signer, especially if you have a good credit history.

Which Loan to Choose?

Your personal situation will determine which loan is best for you. But here are some general pointers. Federal loans should be your first option. Federal student loans are available to most students, they don’t need a co-signer or credit history, and they offer flexible payback options and potential loan forgiveness. They also give you a longer grace period before you have to start making payments.

Private loans can be a good option if you can’t get federal loans or need more money than federal loans provide. They might also be good if you have excellent credit, as you could get a lower interest rate.

Remember, though, loans are a serious commitment. Before taking out a loan, try to exhaust all other funding options, like scholarships and grants. If you need a loan, only borrow what you need to cover your education costs, and always understand the terms and conditions before you sign.

How to Apply for Student Loans

Below is the basic application process for federal and private student loans.

Applying for a Federal Student Loan:

Federal student loans are funded by the government and you apply for them by submitting the Free Application for Federal Student Aid, or FAFSA. 

The steps to apply include:

  1. Submit the FAFSA: The FAFSA is free to submit. If a website tries to charge you, it’s not the right place.
  2. Fill it out annually: You must submit the FAFSA every year if applying for federal student loans.
  3. Timing is crucial: Try to submit it as soon as possible after October 1 because some types of aid come on a first-come, first-served basis.
  4. Check your offer: After you’ve submitted the FAFSA, you’ll receive a financial aid offer that will tell you how much you’re eligible to borrow in federal student loans.

Applying for a Private Student Loan:

Banks and other financial institutions offer private student loans. Unlike federal loans, you apply directly to the lender. Here’s how:

  1. Visit the lender’s website: Each lender has its own application process.
  2. Check loan terms: Look at the interest rate and how flexible the repayment options are. Compare different lenders to find the best terms.
  3. Consider a cosigner: Adding a cosigner, like a parent, can increase your chances of getting approved for the loan. The lender will check both your credit and your cosigner’s.
  4. Wait for a decision: The lender will review your application and then inform you. Decisions can take as little as 15 minutes.

Remember, the private student loan process and terms vary by lender. Additionally, taking out a student loan is a big decision, and it’s important to understand what you’re agreeing to. Only borrow what you need, and always read the fine print before you sign anything.

Student Loan Warnings

If you have student loans, you can expect a rather unpleasant graduation present from the real world: Your lender will want you to start making loan payments. If you don’t, you may wind up in default, and the consequences could be serious.

“Goodbye, cool world,” say teary-eyed college students on graduation day. They know that they have to say hello to the real and cruel world, where bills start appearing for mortgages, autos, and student loans.

Student loans are due even if you’re not gainfully employed or stopped taking classes before graduation. If you don’t make a payment for 270 days, your loan will be in default, which can have negative impacts on your credit profile.

Keep Up with Payments 

If you fail to make a loan payment and don’t have forbearance (only requires payment of the interest on a loan) or deferment (delay of payment for a specified time), you could face rather bad consequences. 

A lender may turn your loan over to a collection agency, and you’ll be responsible for the costs of collecting the loan, including attorney’s fees. You can also be sued, your wages garnished, and your lender can take your federal and state income tax refund. 

The government can also deny you access to any more federal aid and withhold any Social Security payments that you’re currently receiving. Needless to say, all this will wreak havoc on your credit score, impacting your ability to get and access credit.

Preventing and Emerging from Default

The first and most obvious way to stay out of default is to make your payments on time. Keep your lender posted on any address changes that you have. If you can’t make your loan payment, contact your lender immediately. You can request a deferment, forbearance, or some other payment arrangement.

If you fall into default, it’s not the end of the world. You can get out of it by making 9 of 10 consecutive payments within 20 days of the due date. Making these payments may require negotiation with your lender, in which a “reasonable and affordable” payment amount is set. This is considered “loan rehabilitation.” Consolidating your delinquent loan may be another option suggested by your lender.

You may also be eligible for additional Title IV federal aid if you’ve made six consecutive on-time payments.

The consequences of loan default can be severe and have a significant long-term impact on your finances. Even though you can climb out of the jam by making a series of payments on time, it will wreak havoc on your credit score. Choose a healthier economic path: Make your payments on time and stay out of default in the first place. It’s the best way to ensure that the real world welcomes you with open arms.

David Mully

David Mully is president and CEO of Lender Insider, a mortgage consulting firm. With 26 years in the mortgage industry, he has worked as both a mortgage loan officer and in the business-to-business sector of the industry. He is the former author of the weekly “Mortgage Search” column for Observer and Eccentric Newspapers. You can read his blog at http://www.lenderinsider.com/blog.