More than $100 billion in federal education loans and $10 billion in private student loans are originated each year.1 It is big business and the world of student loans can be a daunting and confusing place, especially for young adults who may not have any prior experience with lenders or debt. With the cost of secondary education on the rise each year, it behooves students and parents to make informed decisions about financing education. Here’s an overview of the common types of loans college students are likely to encounter.
Stafford Federal Student Loans are federally sponsored loans available to graduate and undergraduate students. They offer low interest rates and payment is deferred until after graduation.
Stafford loans can be either subsidized or unsubsidized. Interest on subsidized loans is paid by the government while the student is in school. Unsubsidized loans, however, accrue interest while the student is in school. Recipients of subsidized loans must display financial need. All students, regardless of need, are eligible for unsubsidized Stafford Loans.
Stafford Loans allow dependent undergraduates to borrow up to $5,500 their freshman year, $6,500 their sophomore year, and $7,500 for each remaining year.2 Independent students and students whose parents have been turned down for a PLUS loan can borrow an additional unsubsidized $4,000 the first two years and $5,000 the remaining years.3
The Perkins Loan is similar to Stafford Loans. It is a campus-based subsidized student loan awarded to students who can demonstrate exceptional financial need. The interest rate is 5%, and there is a 10-year repayment period and no origination fees. The program limits are $4,000 per year for undergraduate students and $6,000 per year for graduate students, with cumulative limits of $20,000 for undergraduate loans and $40,000 for undergraduate and graduate loans combined.4
The Perkins Loan is desirable because it’s both low interest and subsidized. For either the Stafford Loan or the Perkins Loan, students must fill out the FAFSA form and coordinate with their school’s financial aid office.
Private loans are available from a number of sources and financial institutions and even available online. Private loans are harder to characterize because they are not regulated the same way government student loans are. The terms, conditions and interest rates can vary widely, but generally private student loans have higher interest rates, and those interest rates are determined by credit worthiness, like any other private loan.5
Parent loans can be a good option for families whose finances are stretched thin but who don’t want their children to incur debt. These are a better option than applying for loans online in order to stretch funds between paychecks. Parents of dependent students can take out loans to fund their student’s education. PLUS Loans (Federal Parent Loan for Undergraduates) allows parents to borrow money to cover any costs not covered by the student’s financial aid package. There is no cumulative limit on PLUS loans. PLUS loans are the financial responsibility of the parents, and not the student, i.e., if the student fails to make payments of the loan, the parents are responsible for paying it.6
Whatever route families choose when financing education, they should remember that student loans are binding financial agreements. It’s wise to be fully informed of all the terms and conditions of any financial instrument before entering into ay agreement. Student loans are notoriously hard to cancel in bankruptcy and carry serious consequences for defaulting. Doing your homework now can save headaches and unexpected financial burden in the future.
Authored by Horace Black.