Taking out a student loan is a difficult decision for some but also just a “way of life” to others. It’s not uncommon for people to take out student loans to pursue higher education and in many ways, it is almost expected.
A student loan operates just like other types of debt. There are a few differences between student loans and other loan and debt types that make it some of the most dangerous types of debt to have. It’s very important to research and make the right steps before taking out any student loans.
The first thing to understand than many forget is that student loan debt is still debt. You still owe someone money and in most cases, it’s the government. A couple simple rules still follow: you must pay it all back and it will accrue interest over time.
Student Loan Basics
Let’s just revisit it again because it’s that important. If you take out a student loan you are adding on debt to your name and credit. The term student loan doesn’t change anything about it, you’re simply taking out a loan to pay a bill. This means that you will have to pay back what you borrow and more as it gains interest and the amount will increase how long it takes to pay it back.
A student loan can negatively impact your debt-to-income ratio once it’s time to pay them back and that will affect your ability to get an approved mortgage, car loan, and more.
After you’ve applied for a loan and have taken one out you will have to sign a Master Promissory Note (MPN). The MPN is your signature and guarantees that you’re going to pay back the loan in entirety and any accrued interest that the loan has gained. You’ll have to sign one for government loans and a different one for any private student loans you’ve taken out. This is so the bank, and government, can hold you to paying back your debt to them. This promissory note is essentially their collateral for your student loan.
When it comes to a normal loan to buy a house or a car you use that item as collateral for the loan. If you don’t pay back your loan and default on it then they’ll simply just repossess the house and car and you’ll end up paying the difference after your loan is paid off from them reselling it.
You have no collateral when you take out a student loan aside from your personal future.
A bank is taking a chance that you will find a secure job that will pay you a good wage to pay back the loan. Since there is no collateral involved with a student loan it makes them nearly impossible to get rid of. A student loan has a lot of restrictions that forces it to stay with you, even if you file for bankruptcy. It’s pretty simple, if you take out a student loan then you should expect to spend however long it takes to pay it off.
Types of Student Loans
There are many types of student loans out there but the main two categories are Federal Student Loans and Private Student Loans.
A Federal student loan is issued by the government through the Department of Education. There are multiple types of Federal student loans and multiple types of payment options. A Federal loan servicing company will handle the loan and they are contracted by the government to do so.
A private student loan is issued by a bank or credit union. These loans almost never offer any perks unlike Federal loans. They may offer better interest rates and in some cases better terms since they are trying to be competitive in the market.
The total Federal Student Loan debt: $1.47 trillion.
The total Private Student Loan debt: $123.14 billion.
Federal Student Loans and FAFSA
In order to take out a Federal student loan you need to fill out a FAFSA. This is how the government determines your eligibility for loans. Your application must be filled out and submitted every year starting in your final year of high school until there is no longer a need for aid.
You must fill out the FAFSA ahead of your Fall semester and the earlier you fill it out the better your chances are to get aid.
Aside from the FAFSA, to quality you need to meet certain eligibility requirements The requirements to obtain a Federal student loan are:
- Attend an Eligible School
- No Crime Convictions
These federal loans are based on need and typically only go off of the student’s income and information. The FAFSA may ask for parental information but that won’t affect your eligibility for student loans. It will affect your eligibility for other financial aid awards or grants.
Types of Federal Student Loans
There are two main types of Federal student loans but each type has a few programs under it. The two main student loans from the government are: Federal Direct and Federal Perkins.
In the Federal Direct program there are four types of loans: Direct Subsidized, Direct Unsubsidized, Direct PLUS, and Direct Consolidation.
A Direct Subsidized loan is for undergraduate students who have demonstrated a financial need. The current interest rate for these loans is 4.29%. These types of loans do not charge you interest while they are deferred and you’re enrolled in school.
A Direct Unsubsidized loan is for undergraduate and graduate students but financial need is not needed. The current interest rates are 4.29% for undergraduate and 5.84% for graduate and professional students. The student is responsible for all interest on these loans and it will accrue while the student is in school or the loans are deferred. It’s best to pay the interest each month, if you can, to avoid these growing larger than intended.
A Direct PLUS loan is for parents of a student. You do not have to demonstrate financial need to get these loans but the student must be a dependent under the parent on their taxes. The current interest rate is 6.84% and unlike with other Federal loans, this is based on credit history and you cannot have a negative credit history to get these loans. The borrower is responsible for interest and it will accrue over time. These loans are very limited in their repayment options and should be avoided, if possible.
A Direct Consolidation loan allows you to combine all of your Federal student loans into a single loan with a single loan servicer. The best part is that it’s 100% free. It gives you the ability to make payments easier after graduation. You should try to consolidate your federal loans with the government before turning to any private organization. If you’re interested in consolidating your Federal student loans, go here.
A Federal Perkins loan is for undergraduate and graduate students and depends on your financial need. These funds have limited availability at college and are entirely based on specific questions in the FAFSA you’ve filled out. The college themselves are the final determination for who gets the Federal Perkins loan. The current interest rate is 5% and unlike Federal loans, the college themselves are the lender for a Perkins loan and all of your payments will be to the college.
Private Student Loans
Private loans are different from Federal loans because they do not require you to complete a FAFSA and they are entirely based on loan approval criteria. They act almost exactly like traditional loans except you don’t get the money and it’s used directly on your school costs with little, if any, extra going to you.
The downside to a private student loan is that you almost always need a cosigner, especially if you’re a student with minimal credit history or no job experience or income data. These loans typically have a higher borrowing limit and no income restrictions.
Types of Private Student Loans
There are only two main types of private student loans: undergraduate and refinancing.
An undergraduate student loan is typically given to someone who is currently attending or will be attending a university or college in the upcoming Fall semester.
A student loan refinance is used when you have already graduated and want to change the loan debt terms. The practice of refinancing a student loan is similar in manner to refinancing a mortgage or refinancing a car. To find out more about how you can refinance your student loans and the criteria, keep reading.
Finding Student Loans
So far you have learned some of the basics and you have learned what types of loans are out there. Before you run out and find a student loan or apply for one you need to make sure it still fits in your budget.
If you don’t have a budget, you should learn how to create a budget before making any of these financial decisions. It’s ok to not know how much money you’ll make in the future but you should research common salaries for your target job and make sure it will be enough to cover a student loan payment.
Before you apply for a student loan you should look at other ways to pay for college. These other ways to pay for college can end up saving you thousands in student loan debt and interest.
Student Loan ROI
The goal with student loan debt is to keep your payment less than 10% of your income. A majority of the student loan programs people have applied for have a 10 year life. This means that you’ll be paying off your student loan within 10 years of graduation.
To keep the goal of 10% or less realistic you should research what your expected salary is. For example, if you wanted to be a Software Engineer you can probably expect to get around $65,000 a year right out of college. In some places you may get more and in others less. In the “rule of 10” that means you should only take out up to $65,000 in student loan debt to attend college and receive your degree. If you had to borrow $100,000 to get your degree but you only make $65,000 a year then you’re already well above the 10% goal.
To keep this 10% realistic the formula for success is: Amount of Student Loans < First Year Salary
If you can keep your student loan debt below your first year’s salary then you will have, or shouldn’t have, any trouble repaying your debt and can go to school without any financial stress. If you’re going to be taking out loans that exceed your first year’s salary then you should use your own discretion but we would advise you not to.
If you’re a parent and reading this – you should NEVER take out a loan to pay for a child’s education. There are many options a student can use before even needing to take loans out themselves. A student loan will set the student back around 10 years but it will set the parent’s back even longer and may even cost them their retirement. The only scenario where a parent should pay for the student’s education is if they are using cash or savings that’s not already tied up in retirement.
If you’re looking for a loan you should fill out your FAFSA first and take any federal loans you can and then move into private only if you need to. It’s better for you to tap into your savings than it is to take out a private loan.
Student Loan Repayment
Once you graduate from college you should immediately be thinking about how you’re going to repay your loans. In many cases, students leave college with a job. If you weren’t one of the lucky ones or if you didn’t do the job search prior to leaving school then you’re on a ticking clock.
Many students put off thinking about repayment until that first bill comes. That’s not when you want to be scrambling to find a solution. You only have 6 months after graduation before you need to start paying off your student loans. There are tons of repayment options out there for you to review and understand.
Beware: If you don’t make any choice regarding your student loan debt repayment you will be defaulted into a standard repayment plan. If this plan is affordable, keep the standard repayment as it will be the fastest way to getting rid of student debt outside of paying more. If you can’t afford the standard repayment plan you should be looking at other repayment options, like income-driven repayment.
Standard Repayment Plan
A standard repayment plan is what most students use when they leave college. It’s very similar to making a standard loan payment like you would for a house or a car. You will make equal payments on your student loan for up to 10 years. The minimum payment is at least $50 per month. The standard repayment plan schedule is available and used on nearly all student loan types, even for private student loans.
Graduated Repayment Plan
A graduated repayment plan starts with a lower payment first and gradually gets higher as you make payments. This is a great plan if you have a low income to start but you expect to increase it in a few years. Every two years the payment will increase until you’ve paid off your loan. The loan is still paid off in 10 years and the highest payment will never be more than 3x the first payment.
If you’re not automatically put in a standard repayment plan there is a very good chance you were placed in this plan.
Extended Repayment Plan
The extended repayment plan is meant to lower your monthly payment but it extends the life of the loan meaning you pay more in interest over the life of the loan. It extends the loan to 25 years instead of 10. To qualify for this type of repayment plan you have to have over $30,000 in outstanding debt and must prove financial hardship or that you can’t make normal payments under the previous two plans.
Income Based Repayment Plan (IBR)
An income-based repayment plan is designed to lower your monthly payments due not having a high enough income to make the standard payments. It’s a weird calculation but it basically breaks down you not being able to pay the standard payment and you’re nearing poverty or close to poverty.
The IBR typically changes based on your income so if you end up making more money in a year it will change based on how much money you’re making. The only loan that isn’t eligible for this repayment option is a Parent PLUS loan.
Pay As You Earn Repayment Plan (PAYE)
A pay as you earn repayment plan is designed to lower monthly payments if you’re in financial hardship This plan is only available to borrowers who took out a loan after October 1st, 2007. The program is essentially the same as an IBR plan except it requires you to be closer to the poverty line.
The program isn’t available for all loan types.
Revised Pay As You Earn Repayment Plan (RePAYE)
In an effort to make student loan payments affordable, the RePAYE plan was created to act in the same manner as the PAYE plan. This payment option is identical to the PAYE plan except it’s available for all loan types except for the Parent PLUS loans.
Income-Contingent Repayment Plan (ICR)
An income-contingent repayment plan is used specifically for Direct Loan programs only. It is designed for borrowers that need lower payments but do not qualify for other lower payment options, like IBR or PAYE. In this plan you’ll still make payments over 25 years and your monthly payments will be adjusted based on your gross income.
Your monthly payment will be the lesser of:
- The amount you would have paid if you repaid your loan in 12 years multiple by an income factor.
- 20% of your discretionary income.
The bonus to this plan is that interest is accrued but cannot go higher than 10% of your original loan balance. If you’re still accruing interest after 25 years then the rest of the loan is forgiven and you owe nothing.
Income-Sensitive Repayment Plan
An income-sensitive repayment plan is designed for FFEL loan programs, like the Federal Stafford Loans, PLUS loans or consolidation loans. In this plan the payment will increase or decrease based on your annual income. The payments will be made for 10 years and after the 10 year mark they may be forgiven.
If your loans are forgiven, you may end up owing taxes on the amount that is forgiven. If you’re trying to use an income based plan to get your loans forgiven without paying them off entirely then you shouldn’t plan on paying more or plan on any major discretionary spending. If loan services find out you’ve been paying extra or have been spending money on lucrative items (several houses, cars, etc.) then you could lose your chances at being in the plan or for forgiveness.
If you’re trying to buy a house on an income driven plan, you could run into barriers and may need to work with mortgage companies to overcome some of their lending requirements. A lender won’t typically use your monthly payment to make a decision but instead will use the total student loan debt you have and income driven plans typically hold a much higher debt-to-income ratio than a standard repayment plan based on how they are structured.
Student Loan Deferment & Forbearance
A student loan deferment allows you to postpone any payments on your student loans until a certain period of time. The most utilized deferment is when you’re still in school. Most loans automatically come with a 6-month grace period where you don’t have to make payments until you’ve been out of school for 6-months.
Outside of standard deferment periods there are other deferment options you can sign up for and try to qualify for. These programs can coincide with student loan forgiveness programs. For example, if you joined the Peace Corps you can qualify for deferment and forgiveness of some of your loan.
|Action Programs Deferment||36 Months||Must be a paid full-time volunteer in ACTION programs.
Must agree to serve at least one year.
|Armed Forces Deferment||36 Months||Must be on active duty in the armed forces of the United States (Army, Navy, Air Force, Marine Corps or Coast Guard.
Reserves may qualify if you are serving at least a year full-time or are serving under an order of national mobilization.
You must submit a copy of your military orders to your loan holder before applying.
|Economic Hardship Deferment||36 Months & Apply Annually||You are receiving payment under a federal or state public assistance program.
You are working full-time and your total gross monthly income is less than or equal to the larger of the federal minimum wage rate or 150% of the poverty guideline for your state.
|Graduate Fellowship Deferment Program||No Limit||You must enroll in a fellowship program that provides sufficient financial support to allow for full-time study for at least 6 months.
You must have a Bachelor’s degree conferred by an institution of higher education.
You must have already been accepted into a fellowship program.
|In-School Deferment Program||No Limit||You must be enrolled in an eligible school at least half-time.|
|Internship/Residency Deferment Program||No Limit||Your internship/residency must be a supervised training program.
Your internship/residency must lead to a degree or certification.
You must at least hold a Bachelor’s degree before acceptance into the program.
You must have a deferment form signed by an authorized official of the organization where you are taking the program.
|Parental Leave Deferment||6 Months||Federal PLUS loans are not eligible.
You must be pregnant, caring for a newborn child, or caring for a newly adopted child.
You must not be working full-time or attending school.
You must have been enrolled in school at least half-time during the six months prior to deferment.
|Peace Corps Deferment||36 Months||You must agree to serve in the Peace Corps for at least one year.
You must have your deferment signed by a Peace Corps official.
|Post-Active Duty Student Deferment||13 Months||Must have completed active duty military service and were called into active duty at the time of or within 6 months of attending school at least half-time.
Member of the National Guard or Armed Forces Reserve.
|Military Service Deferment||No Limit||Serving on active duty during a war or other military operation or national emergency.
Loans must be Stafford Loans, PLUS Loans or Consolidation Loans.
Must provide loan holders with copies of military orders.
|Tax Exempt Organization Volunteer Deferment||36 Months||You must be serving full-time in an organization that is tax exempt under Section 501(c)(3).
You must assist low income people and their communities in eliminating poverty.
You must not earn more than the federal minimum wage.
You must not engage in religious instruction, proselytizing, fund raising or conduct worship services as part of your duties.
You must have agreed to serve in this organization for at least one year.
|Teacher Shortage Area Deferment||36 Months||PLUS Loans are not eligible.
You must teach full-time in a public or non-profit private elementary or secondary school in a shortage area defined by the U.S. Department of Education.
|Temporary Total Disability Deferment||36 Months & Apply Bi-Annually||The disability cannot be a pre-existing disability that you’ve had before applying for loans.
You cannot claim due to pregnancy complications.
You can claim for a spouse who has a temporary disability not allowing you to work full-time.
|Unemployment Deferment||36 Months & Apply Bi-Annually||You must be seeking a full-time position of employment.
You must be registered with a public or private employment agency within 50 miles of your address.
You must have 6 diligent attempts at gaining employment every 6 months.
|Working Mother Deferment||12 Months||Federal PLUS Loans are not eligible.
You entered or re-entered the workforce within one year preceding this deferment request.
You are working full-time in a position earning no more than $1 per hour above Federal minimum wage.
You are a mother of a preschool-age child who has not enrolled in first grade or higher.
|PLUS Borrower with Depending Student Deferment||No Limit||You must have a student enrolled full-time at an eligible school.|
How to Apply for Deferment Programs
In order to apply for any of the deferment programs above you will need to follow all the proper steps and download the right forms to fill out and mail them in. If you’ve followed the steps accordingly and you qualify you typically will see the deferment happen immediately.
All of the deferment programs require a written application. You should not call your lender to apply, however, they may be able to guide you to the correct program or paperwork. All deferment programs are subject to your lender’s approval.
Student Loan Forbearance
Forbearance is when the student loan holder gives you permission to stop making payments for a set period of time. There usually is no qualifying reason a person gets forbearance aside from financial hardship. A deferment is tied directly to a student loan program whereas a forbearance is only tied to the terms of the loan.
Even in forbearance you’re still going to be accruing interest and a forbearance is usually granted in a larger amount of time and in chunks, typically around one-year. A forbearance can be much easier to obtain than a deferment depending on the student loan type.
A forbearance can be requested for the following reasons:
- Poor health preventing work
- Inability to pay within the maximum repayment terms
- Monthly payments totaling more than 20% of a borrower’s monthly income
Student Loan Forgiveness
There are several ways to get a student loan forgiveness and if you’re in the right career it is technically free money on the table to be picked up. In some circumstances you can see a large chunk or even all of your student loan cancelled but to qualify you must perform volunteer work, military service, practice medicine in poverty stricken areas, or meet some other criteria.
There are a few programs available:
- Public Service Loan Forgiveness
- Repayment Assistance Programs
- Cancellation and Discharge Programs
- Repayment Terms & Agreements
As nice as forgiveness sounds, keep in mind that you’re still liable to pay taxes on the money they forgave. The money that is forgiven is considered taxable income and it could end up costing you when tax season comes around.
Public Service Loan Forgiveness
The way most students get their loans forgiven is by going into public service. If you go into public service and have worked in public service for at least 10 years, meanwhile paying your student loans, they will forgive the rest of your student loan debt no matter how much it is.
The perks behind this program is that the definition of “public service” is very broad. An employer can be with federal, state, local, an entity or even a non-profit organization.
Some common jobs that qualify for this forgiveness include:
- Government Workers (Federal, State and Local)
- Emergency Management
- Public Safety or Law Enforcement
- Public Health (DHS)
- Public Education or Public Library Services
- School Library or Other School-Based Services
- Public Interest Legal Services
- Early Childhood Education
- Public Service for Elderly or Disabled
Repayment Assistance Programs
A student loan repayment assistance program is a program that gives you a certain amount of money towards your student loans for completing certain requirements. There are a variety of student loan repayment assistance programs available.
The main repayment assistance programs at the Federal level is from volunteer work. The two main programs are the Americorps and the Volunteers in Service to America (VISTA). Both of these have time limits and if you meet these time requirements they will give you $4,725 towards paying off your student loans.
At the time of writing, 45 states offer at least one student loan repayment assistance program. The qualification and requirements, along with how much they give you, are different for each state. You’ll want to follow up with your state’s department of education to see the programs available.
If you haven’t taken advantage of a repayment assistance program then you may qualify for other repayment programs themselves. A few of these outlined in previous sections, like IBR or PAYE, allow you to pay back your student loan for a fixed time period and after that time period has been met (and you’ve paid what you could) then your loans will be forgiven in full.
Student Loan Refinancing and Consolidation
If you have multiple student loans, most do, you have likely considered finding ways to refinance or to consolidate your loans into a single loan. There are many places that use these two terms interchangeably but they do mean different things.
A student loan consolidation is only for Federal student loans and it’s typically only done for convenience. Instead of paying 10 different student loan accounts you only pay one. In this case they take the average of all the interest rates and that’s your new rate and you’re still stuck paying a higher interest rate for the life of the loan.
A student loan refinance is for Federal and Private student loans and is typically done to merge everything into a single loan, like a consolidation, but when you refinance you can negotiate your terms and in many cases get a lower interest rate. You’re basically taking out a brand new loan to pay off your old loans. These loans are almost always provided by a private party and are not privy to the deferment and repayment options that come with federal loans.
Should You Refinance Federal Student Loans?
In short, the answer is up to you. Our advice would be to never refinance federal loans as the moment you do you lose out on any assistance or programs that the Federal government offers to help you pay back your student loans.
The programs and assistance plans created by the Federal government are meant to help students manage their student loan debt and make payments towards it without pushing them towards poverty. Not only are there programs to help with payment but if you refinance you lose any chance at loan forgiveness as well.
The only time we suggest refinancing Federal student loans is if you have 0 intention to not pay the standard repayment plan rate for the full 10 year term of the loans.
Student Loan Default and Rehabilitation
In some cases it’s hard to keep up with your student loan debt or payment. If you haven’t made a payment on them in over 270 days then they are placed in default. If your loan goes into default they are typically transferred over to a collection agency fairly quickly.
If you let your student loan default, there are some heavy consequences. It will destroy your credit and will take you years to get it back to where it was or where it should be. The collection agency will be assigned to recover as much debt as possible and will have the backing of the Federal government. This means that they can recover the debt in several ways like wage garnishment, tax refund offsets or even garnish your Social Security. Basically if you have any source of income and you’ve defaulted on your student loans, you can expect the government to take a decent chunk of it.
Student Loan Collection Rights
Even though you’ve defaulted on your loan, you still have rights.
For example, the debt collector:
- Can not do early morning, late night or repeated/continuous phone calls.
- Can not call you at work if you direct them not to.
- Can not discuss your debt with anyone else but you.
- Must send you a written notice of the debt.
- Must honor your request for no further contact.
- Must verify all disputed debts in writing.
Student Loan Rehabilitation
Student loan rehabilitation is the process where you get your Federal student loans out of collections and be able to get on a repayment plan that works with you.
The first thing you need to do is get a list of every one of your student loans and make sure you have any and all of the lender’s contact information.
Now that you’ve found your debts, you have a few options:
- Pay Off the Loan – the best option but not always the easiest is to just pay off the loans entirely.
- Loan Consolidation – you can consolidate your loans to one single payment instead of multiple.
- Loan Rehabilitation – you have to contact your lender and you will negotiate with the Department of Education on a reasonable and affordable payment plan.
If you have rehabilitated your student loan then you will now be eligible for the benefits that were available for your loan to begin with. These include the many deferment and repayment options.