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How Student Loans Work
More people than ever are facing student debt.
With college being more accessible to Americans, and with increased scholarships and grants, colleges continue to fill up with students.
You most likely are embarking on a college journey or are concerned about your impending student loan debt. However, don’t fear! It can get scary when looking at how long it will take to pay off your debt, and how much interest accrues. It adds up.
As a student with loans, it is important to understand the following 4 principles:
- The difference between types of student loans
- How interest affects student loan payments
- How to pay back student loans
- Loan consolidation and loan refinancing
Before diving into how student loans work, I want you to consider the following 3 topics regarding your personal finances and debt:
1. Do you have financial goals for your future?
More and more young Americans are finding easy ways to earn fast. Social media and the Internet allow nearly everyone the opportunity to make money. Some create YouTube accounts, others blog.
This, unfortunately, is skewing the perception of saving, investing, and earning an income for many millennials! Take a minute when reading this article to really think about how you want to see yourself in 3, 5, and 10 years from now.
Do you want to retire early to have the opportunity to travel? Would you like to have enough money to live in a specific home to raise your children?
Be sure to learn how to earn extra $50 cash each day!
2. Do you know your current net worth?
Your “net worth” literally means how much you are worth. This includes money you have in the bank, debts you owe like car loans, and anything you have invested.
There is an awesome free app I use called Personal Capital that allows you to fully track your spending, budgeting, investing, and overall net worth!
If you want to pay off your loans quickly, it would be smart to start tracking it from the very beginning! If you already have loans to your name, then you really should know your net worth so you can start learning how to pay it off and watch your worth increase as you pay off the debt!
3. Are you aware of how much debt you will accrue in interest?
Very few people actually know how much school will really cost them! It can range significantly from state to state and from school to school. One student may be paying $60,000/yr while another may be accruing $15,000/yr for the same degree.
You’ll begin to build interest on your loans and many don’t realize how fast this will grow.
Be sure to utilize one of the many student loan calculators you can find on Google to get an idea of how much you’ll actually have to pay in the end. Interest adds up fast!
1. What are the Different Types of Student Loans?
TIt is important to understand where your loans are coming from and what to do with them! Loans means that someone is giving you money today, expecting you to pay them back at some time in the future.
To begin, your loans will be coming from one of two places: The government or private.
The government
Student loans from the government are called “Federal” loans. They are coming from the federal government!
These can come in many different ways:
- Subsidized – the federal government “pays” the interest for you while you are in school. Meaning, you won’t have to pay interest until you are out of school. This is typically how undergraduate loans work.
- Unsubsidized – once you take out the loan for the semester, interest begins accruing. This is common with graduate school loans.
- PLUS – These loans are on top of the subsidized or unsubsidized loans. Those other loans cap at a certain amount, and if you need more money to live during school or to pay for more fees, a PLUS loan is helpful for that. Watch for how much you take of these, because PLUS loans come at a higher interest rate!
Fun fact: If you have an extremely unfortunate circumstance where you pass away early while having student loans in your name, the government will forgive those amounts and not require your family or spouse pay them back.
Private Loans
Private loans come from anywhere but the federal government. For example, this could be from family, a company, or bank. There are fixed and variable loans, but each bank, company, or individual would require completely different stipulations with their loans.
Some have lower interest rates, some have higher. It is very important to do thorough research if you are considering one of these loans.
Fun fact: These loans are typically not forgiven if you pass away before they are paid off. Also, companies can consolidate or refinance your loans, which can cause your federal loans to become private loans. We aware of this if you choose to take one of these options!
2. How Does Interest Affect Student Loans?
Remember what we stated above? When someone loans you something, it means they expect it to be returned.
Nothing in this world is free, and the government or company you borrow money from is only letting you borrow it with a stipulation: they get to charge you money to borrow that money.
That’s where interest comes in.
For undergraduate student loans, you could expect somewhere around 3.5%, but it ranges all the time. Graduate school loans jump in interest and are around 6.5% interest.
Interest builds on itself. Meaning, you’ll have to pay 6.5% (or whatever your interest rate is) of the amount you owe, yearly.
As that interest continues to add onto your original amount, the interest is calculated on the amount of money you owe overall, including the interest. This means you will keep having to pay more interest each year that passes if you don’t pay! (There is a minimum payment that is typically required to pay each month that will be determined by the loaner).
Be sure to check out these articles to improve your personal finances!
- The Top Personal Finance Books For High Schoolers to Retire Early
- 10 Huge Money Mistakes to Avoid in Your 20’s
3. How do I pay back my loans?
There are two main ways to pay back your loans: Cash and through loan forgiveness.
Cash
Most people end up paying their loans over a period of time with their own money.
If you follow a method like Dave Ramsey’s snowball method, then you could get your debts paid off quicker than just blindly throwing money at it every month.
It is important that you first understand your net worth as mentioned above, so you can see how much money you owe, how much you have invested (if you have any), and understand your cash flow.
Loan Forgiveness
Federal student loan forgiveness was created back in 2007. It stated that if you work for a nonprofit (or another qualifying company), for 10 straight years, then they will pay back your student debt.
2017 was the first cohort of graduates who made it through the 10 years of working to get their debts paid back. The unfortunate news: very few of them actually got their debt paid off.
Why?
A significant amount of students didn’t get great direction about what to do to file all the documents for the payback, or they didn’t end up working at the one location for a full 10 years, or they didn’t stay regular with minimum payments on their student loans.
Long story short: if you want to participate in one of these programs, do your research first!
Other options
There are other ways to get your money paid off, including the military, or working in rural areas.
Every person will have a completely different situation. Be sure to have open conversations with your family or spouse about what may be best for you, and seek out professional advice!
4. How Does Loan Consolidation and Refinancing Work?
Consolidation
When you consolidate your federal loans, it means your multiple loans will be combined into one. As you go through each semester, you’ll notice that you have numerous loans, at possibly different interest rates.
The point of consolidation is so you aren’t paying on lots of different small loans, and rather, one large loan at one interest rate. You still will be paying one monthly amount.
Unless you have high interest loans, this option may not necessarily save you money!
Refinancing
To refinance, you allow a bank/company to combine your loans (federal and/or private) into one private loan. Your federal loans will now be private loans.
This actually has the possibility to make your interest rate decrease so you would pay less in the long run. Not every private company will accept your application to do so, however.
They may favor those with more education (higher degrees), which gives them more peace of mind that you’ll pay them back, those with good credit, and those with good cash flow.
By refinancing, however, you cannot do public loan forgiveness. Make sure to look into all your options before making a choice about what to do with your loans!
Summary of How Student Loans Work:
- If you are still new to understanding student loans, just be sure to start learning about your own personal financial situation before getting overwhelmed!
- As you go through school, keep track of how much is accumulating and be aware of your interest rates. Regularly calculate how much you’ll have to pay if you’d want to pay off your loans in 5, 10, 15, etc. years.
- Remember that you can’t ignore your student loans! You will have to pay some type of monthly payment once you’re done with school.
