The Reality of Student Loans: 3 Things You Should Know

Student at computer applying for student loan.

The highly publicized “debt forgiveness” gifted to 400 Morehouse College graduates by Texas billionaire, Robert Smith, was real cause for celebration. Smith, during his commencement address at Morehouse, announced his plans to pay off the student loans of each graduate to the tune of 40 million dollars. Students were elated. Parents were even more elated. The typical outstanding student loan for graduates of Morehouse College with a bachelor’s degree is $26,000, according to the US Department of Education’s College Scorecard.

Most undergraduate students will need to take out student loans to fund part of their college education. In 2016-17 school year, 46 percent of first-time, full-time undergraduate students were awarded a loan; in 2015-16, 62% of students who graduated with an undergraduate degree had received at least one loan, according to the National Center for Education Statistics.

Student debt can become a crisis if students fail to develop a plan and stick to it. Therefore, parents and students should discuss how they will fund college before students apply to college. As a first step, families should figure out their Net Price to determine if they will need to take out loans to cover part or all of their cost of attendance.

By all means, consider strategies to cut college costs. Attending a collegiate high school or taking dual credit courses, for instance, could help students earn college credits while still in high school and reduce their overall college costs. Other cost saving measures include taking a test prep class to raise your test scores and qualify for more merit scholarships, and targeting generous colleges.

>>RELATED: How to Cut College Costs

If student loans are part of your plan to fund your education, here are three (3) things you should know:

1. There are different types of student loans

First, two of the main sources of student loans are the federal government and private institutions (banks, colleges, state agencies or other financial institutions). The loans available through the federal government are generally a better option than private student loans due to the lower interest rates and more flexible repayment terms. Most importantly, your first step in accessing these loans is to complete and submit the FAFSA.

The federal loans available to fund your undergraduate education are:

  • Subsidized loans are available to undergraduate students with demonstrated financial need (as determined by information submitted in FAFSA)
  • Unsubsidized loans are available to all undergraduate, graduate and professional students with or without demonstrated financial need.  
  • Direct PLUS LoansParent PLUS Loans are available to parents of dependent students. If parents pass a credit check, they can borrow for their student up to the full cost of attendance minus any financial aid the student receives.

How much federal loans can you borrow?

Undergraduate dependent students can borrow up to $5,500 as a freshman, $6,500 as a sophomore, and up to $7,500 as a junior and senior. On the other hand, students who are classified as independent will be able to borrow up to $9,500 as a freshman, $10,500 as a sophomore, and up to $12,500 as a junior and senior.

If your parents are unable to qualify for a PLUS Loan (for e.g., due to poor credit and/or inability to find a qualified endorser/co-signer), as a dependent student, you may be able to receive more Unsubsidized Loans. Loans for undergraduate students usually have a 10-year term.

Who is Eligible?

Students who are attending college at least half-time are eligible for these loans. The subsidized loan is based on financial need; however, the unsubsidized loans are available for any student attending a college that participates in the Direct Loan program.

Parents of dependent students can apply for a ParentPLUS loans to fund their student’s education. They must show they are creditworthy to qualify or find a co-signer with a great credit score.

Students or parents who have previously defaulted on loans may not be eligible for federal (or private) student loans.

2. Student Loans might be part of your financial aid award

Second, loans can make up part of a student’s financial aid award. Although most students hope for a full-ride scholarship, the majority of students will only get enough scholarships and grants to partially cover the cost of attendance. The students that fall into the top 10-25% of the applicant pool will, in most cases, qualify for more merit aid than students in the rest of the applicant pool.

Colleges use merit aid to attract the best and the brightest. The exception to this rule is the highly selective and Ivy League colleges that do not offer merit aid, but instead offer very generous need-based financial aid. Both low-income and high-income families can qualify for need-based financial aid. For example, Yale University meets 100% of student financial need without loans (most colleges do not) even for families earning above $200,000.

>>RELATED: 5 Tips to Appeal A Financial Aid Award

3. If you have to borrow, start with federal loans

Third, federal student loans are available to students attending college with and without financial need. These loans generally have lower interest rates and more favorable repayment terms than private student loans. For example, the current interest rate for Direct Subsidized and Unsubsidized Loans is 5.05% (May 2019) compared to rates from private institutions which could go as high as 12%. Moreover, interest rates for private loans will depend on the borrower’s (parent or student) creditworthiness (credit score).

Some other advantages a federal student loan offers:

  • Interest-free loans while in college: The federal government will pay the interest for recipients of subsidized student loans (based on financial need) while they are in college. This is not available with private loans.
  • Income-based Repayment Options: Several income-based repayment options are available to make repayment more manageable. Students can apply to get their monthly student loan payments reduced to a percentage of their income.
  • Co-Signer not required: Students applying for federal student loans you do not have to pass a credit check and, therefore, will not need a co-signer. Parents, however, must pass a credit check to access the Parent PLUS Loans. The exception to this rule is if you have previously defaulted on a student loan you will become ineligible to receive additional federal student loans. Students applying for a private student loan will, more than likely, need a co-signer.
  • Loan Default: It can take 90 days after a missed payment for a federal loan to be considered in default. On the other hand, most private student loans will go into default after missing a payment for 30 days.

    To avoid federal student loan default, students should exhaust all of their options through loan deferral (pausing payments for a specific period of time) and forbearance (pausing or reducing your payments for a specific period of time).

    To avoid default, talk to the loan servicer about your options. Defaulting on a loan will negatively impact your credit score and your ability to get additional student loans, purchase a car, rent an apartment and, in some cases, get a job. Many employers also run a credit check during the hiring process. Any signs of financial trouble on your credit report (for e.g., late payments and loan defaults) might cause employers to consider you a liability.

To sum it all up, student loans are an option available to help you fund your college education. However, you should borrow responsibly. Do not fall into the trap of borrowing the maximum amount of loans available to you.