Student Loans

A Guide to Student Loans

With the cost of college what it is today, very few families can pay for college without the aid of student loans. Families need to understand what the options are and how they work to make smart financial decisions for the future of both the student and the parents. We have prepared this introductory guide to get you up-to-speed on some of the basics about student loans and the options available to you.

Buckle up…this is a long post, but we have lots to cover!

Before we get into all that, we want to stress this point.

Loans are meant to cover small gaps between what you can afford to pay and what the actual cost may be. A successful plan to pay for college includes understanding:

  • How much your family can afford to pay – savings, 529, cash flow (the monthly cash you would be spending on your child if they were home), etc.
  • How much college will cost – check out our blog on Net Price Calculators
  • What types of aid are available for your family – need-based grants, merit-based scholarships, etc.
  • What credit your student may enter college with (from dual enrollment, AP or IB)

All these pieces fit together to give you an idea of what your gap or loan needs will be. Be sure to catch Smart Money Moves for the College-Bound program to learn more about all this.

Types of student loans

Student loans can be divided into two groups—federal and private. It is important to understand how they are different from each other to make smart choices. Because every family’s situation is different, we recommend this article should be used merely as a starting point to understanding which loans are best for you.

Federal loans (“Direct”) – At a glance

  • Supported and regulated by the federal government.
  • FAFSA completion is required.
  • May be need based (subsidized) or not need based (unsubsidized).
  • Are issued in the student’s name.
  • Do not require credit approval.
  • Are limited to a specific amount that you can borrow each year.
  • Provide some repayment plan choices.
  • Have some options for when you can’t make payments.
  • Have a fixed interest rate. The rate is usually lower than private loans.
  • Payments are deferred until 6 months after graduation or when your enrollment drops below half time.
  • Loans can be consolidated into one loan.
  • No prepayment penalty.
  • “PLUS” parent loans differ from some of the above
    • They are issued in the parent’s or graduate student’s name.
    • They do require a credit check.
    • The amount you can borrow is not capped and can go up to the entire cost of attendance.
    • Payments will begin while the student is in college unless parents request deferral until after graduation.

Let’s take a closer look at some of these.

Subsidized vs. unsubsidized

Subsidized student loans are awarded to those in need. Completion of the FAFSA provides the government with the information they need to make this determination. Because of this need, the government will make interest payments while the student is in college. Unsubsidized loans are for everyone else. Loan interest will accrue on unsubsidized loans but will be deferred until after graduation. At that time, it will be added to the principal you owe. If a parent has deferred PLUS loan payments while the student is in school, the loan interest will also accrue.

Limits to borrowing

Federal student loans are subject to a maximum dollar amount you can borrow each year depending on your status. They also have a lifetime limit.

Being considered an “independent student” is not based on whether a student is claimed on a parent’s federal taxes. Dependency is based on several variables including age (over 24), marriage status, having children, etc. A complete list can be found here.

Note that subsidized loans have a sublimit. A freshman student who qualifies can borrow up to $3,500 in a subsidized loan and can borrow an additional $2,000 in an unsubsidized loan.

Chart courtesy of US Department of Education
Grade YearDependent StudentIndependent Student
Freshman$5,500 (No more than $3,500 of this may be in subsidized loans.)$9,500 (No more than $3,500 of this may be in subsidized loans.)
Sophomore$6,500 (max. $4,500 subsidized)$10,500 (max. $4,500 subsidized)
Junior & Beyond$7,500 (max. $5,500 subsidized)$12,500 (max. $5,500 subsidized)
Graduate/Professional StudentNot applicable$20,500 unsubsidized only
Cumulative/Lifetime Limit$31,000 (max. $23,000 subsidized)$57,500 (max. $23,000 subsidized) $138,500 for graduate or professional students (max. $65,500 subsidized loans from undergrad)

Parent PLUS loans can be taken out up to the cost of attendance as determined by the college minus any other financial aid received. While no limit sounds great, PLUS loans can be where families get in the most trouble financially.

Interest rates

The interest rate of a loan is determined at the time you borrow the money. Interest rates are adjusted for new loans every July 1st. They are set by Congress and are based on 10-year Treasury notes, plus a fixed interest rate. Rates are capped to a certain amount. For example, the Direct Unsubsidized loan for undergraduates can never go above 8.25% according to the current law.

Interest Rates for Direct Loans First Disbursed on or After July 1, 2021, and Before July 1, 2022, US Dept of Education

Loan TypeBorrower TypeFixed Interest Rate
Direct Subsidized Loans and Direct Unsubsidized LoansUndergraduate3.73%
Direct Unsubsidized LoansGraduate or Professional5.28%
Direct PLUS LoansParents and Graduate or Professional Students6.28%

Loan fees

Loans also have fees which are deducted before funds are paid to the college. They are a percentage of the total amount borrowed. So, remember the amount you borrow will not be the same as the amount you receive. Changes to the fee are effective October 1st each year.

  • Direct Subsidized and Unsubsidized Loans disbursed prior to 10/1/2022 have a loan fee of 1.057%.
  • PLUS Loans disbursed prior to 10/1/2022 have a loan fee of 4.228%. The PLUS Loan fee is pretty steep. A fee of $232.54 will be charged up front on a $5,500 loan. A private student loan may have better terms depending on your credit score.

Repayment

Federal loans come with several repayment options. Payments start six months after a student graduates, leaves school, or drops below half-time enrollment (usually six credit hours per semester). (Remember, PLUS loan payments begin during enrollment unless a deferment is provided.) If you set up automatic monthly payments from your checking or savings account, you qualify for a 0.25% interest rate reduction.

The billing and customer service on the federal loan will be handled by a third-party loan servicer. You may have a different servicer for each year you take out a loan. Helpful tip: Notify your loan servicer when you graduate, withdraw, or drop below half-time status. Remember after you graduate to be sure to keep your loan servicer informed when you change your address, email, or phone number.

Also, be proactive contacting them if you are having trouble making payments. It is better to explore options before you find yourself in a deeper hole.

Repayment plan options:

  • Typically, loans are repaid over a period of 10 years with a fixed amount due each month.
  • A graduated plan has lower payments at first that increase over a 10-year time period. Because of the way interest works, you’ll be paying more over the life of the loan with this plan, but the lower initial monthly payments will help if you are struggling to make payments in the beginning.
  • If you owe over $30,000, you can get an extended repayment plan which stretches the payments (either fixed or graduated) over 25 years. Your monthly payments will be lower for the life of the loan, but again you’ll be paying more in total.
  • Several different income driven repayment plans are based on your monthly discretionary income. We won’t go into all the details in this article. (You can find details here.) Monthly payment amounts are recalculated each year based on updated information you provide, but won’t be higher than the amount of the standard 10-year plan. If your loan balance has not been paid off in full by the time you reach 20 or 25 years of payments, any remaining loan amount will be forgiven. You will owe income tax on any amount that is forgiven.

When you can’t make payments

Explore the available repayment plans mentioned above. Also learn more about deferment, forbearance, forgiveness, and discharge. Your specific circumstances will determine if you qualify for any of these. Be aware that bankruptcy does not automatically mean your federal student loans will be forgiven. You read more about that here.

Where can you get more information about federal loans?

Private loans – At a glance

Ok. That’s a lot! You can see that federal loans have very specific rules and include special options that not all types of loans provide. Private loans are the alternate to federal student loans and should be considered when federal loans are not enough or the terms of the private loan are better than the federal (like the PLUS Loan).

  • The lender is a bank, online lender, or credit union.
  • Terms and conditions (fees, interest rates, repayment terms) will vary by lender.
  • A credit check will be required.
  • Interest rates and terms will be determined by your credit score.
  • Loans issued in a student’s name will need a qualified co-signer unless the student has strong credit. Some lenders will release a co-signer after 12, 24, or 36 months of on-time payments and a good credit rating.
  • Interest rates may be fixed or variable. Variable interest rates can change over time.
  • In addition to interest rates, lenders may charge up-front fees. A 3 to 4% up-front fee equals a 1% higher interest rate.
  • The amount you can borrow is higher than federal loans. The maximum lifetime amount you can borrow varies by lender but could be as high as $500,000.
  • Payments will start while the student is still attending college unless the lender allows you to defer.
  • Loans may be refinanced.
  • Check with the lender to see if there is a prepayment penalty.
  • Usually, they do not offer the variety of repayment options that federal loans do.

Lots of variety

Because you can find tons of lenders, you will also find a wide variety of terms and conditions for loans. Borrowers must read carefully to compare apples to apples when choosing a lender.

Some questions you should ask when considering a private student loan:

  • What is the interest rate?
  • Is it fixed or variable? If variable, how often is it adjusted?
  • What is the loan fee? Sometimes the loan fee will be higher for a lower interest loan. Look at the whole picture.
  • When do payments start?
  • Can you make interest-only payments while in college?
  • Are there prepayment penalties?
  • What happens when the borrower defaults? Is the co-signer (usually the parent) responsible?
  • Are there repayment options if a borrower has trouble making payments?

Calculators like this one can help you plug in terms, rates, and fees to easily compare monthly payments.

Smart borrowing

Borrowing money for college is a huge step for students. They are making decisions that will impact their future financial life so be sure the family works together to make smart choices.

Be sure to consider a student’s starting salary when figuring out how much you can borrow. Friend of At The Core, Capstone Wealth Planners, recommend not borrowing more than the amount of the expected annual starting salary. That guideline will make monthly payments more manageable.

Create a hypothetical budget for after college graduation. It can be an eye-opening project to see how student loans will impact your spending.

Parents don’t forget to consider your retirement plans when thinking about student loans. How far away is retirement for you? Will you be taking on loans? If you plan on borrowing money for your student’s college education, understand that the decision may push retirement back a couple years.

Few families can afford college without student loans. An understanding of how loans work allows families to plan and make the smartest choices for a healthy financial future.


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