Student Loans 101: Here’s What Every Responsible Borrower Needs to Know

Even if you’ve socked away cash from your birthday cards since you were in middle school, saved up money from part-time jobs, applied for all types of scholarships (yes, even the obscure ones sponsored by the potato council or Duck Tape), you may still need student loans to help cover the cost of skyrocketing tuition. 

Go ahead and file student-loan debt in the “not-so-fun” category of college, along with midterms and 8 a.m. classes. But, unlike the latter, student-loan debt really starts nagging you post-graduation, requiring a good chunk of your hard-earned paycheck each and every month. They help you get through college. How will you ever repay them? 

Here is a crash course on student loans, including the different types of loans that are available and how interest works.

Student loan debt climbed to an all-time high of $1.4 trillion in 2019, surpassing credit card debt and auto debt,  according to a report from Experian, one of the three major credit bureaus. That’s an increase of 116 percent in the past decade. 

Womp, womp.

But, on a more granular and personal level, how much debt can you expect to amass by the time you reach graduation? That, of course, varies by student, but we can take a look at averages.

• 69 percent of students in the class of 2018 took out student loans and graduated with an average debt of $29,800, including both private and federal debt, according to data analyzed by Student Loan Hero.
• Meanwhile, 14 percent of their parents took out an average of $35,600 in federal Parent PLUS loans.

Aside from saving for college for as long as you can remember and working a part-time job, other strategies that can help you lower your debt include applying for scholarships and grant money, says Marie O’Keefe, a Certified Financial Planner with Northwestern Mutual. She also suggests being realistic about how much you need to borrow as you may be awarded more loan dollars than you actually need once you’ve budgeted for tuition, books, fees, and living expenses. Extra loan money sitting in your savings account is not likely accruing the interest you’ll be charged on those private or unsubsidized loans.

The terms of your student loans may be totally different from those of your roommate’s loans. That’s because there are sizeable differences between loan types when it comes to how interest is charged and what’s required to take out the loans. 

Federal loans are borrowed from the U.S. government and they fall into two categories: Subsidized or unsubsidized, explains Logan Allec, a Certified Public Accountant, personal finance expert, and founder of Money Done Right. Under these programs, the U.S. Department of Education is your lender. These types of loans are commonly referred to as Stafford loans.

Direct Subsidized Loans are for students who demonstrate financial need to help cover the cost of college. Whether or not you qualify is determined by the almighty Free Application for Federal Student Aid, AKA the FAFSA form. The government pays interest on these loans while you are in school, during the six-month period after graduation and during loan deferment. Direct Unsubsidized Loans don’t require students to demonstrate financial need, but the government won’t pick up the tab on any of the interest accrued on your loan.

Your college or university may also offer institutional aid. The amount offered under this loan type is often capped at a certain amount and it’s common that this loan type requires students to demonstrate financial need, explains Michelle Mai, A Certified College Funding Specialist and CEO and founder of College Planning Source. 

In addition to institutional aid and federal loans, private loans are available, and involve borrowing from a private company. In order to receive a private loan, you or your co-signer may need a credit check, Allec says. 

Also, federal loans have fixed interest rates that don’t change over the life of your loan, and that are set by law each year, explains Mark Kantrowitz, publisher and vice president of research for Savingforcollege.com. Private student loans, though, may offer fixed or variable interest rates, which are set by the lender.

Fixed rates for federal loans are determined each spring for loans made in the upcoming year, which runs from July 1 to June 30.

Here’s what the feds set interest rates at for the current school year, broken down by loan type:

• Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduates: 4.53 percent.
• Direct Unsubsidized Loans for graduate or professional students: 6.08 percent
• Direct PLUS loans for parents and graduate or professional students: 7.08 percent

Curious how those rates fare with past years? Looking back at figures since 2006, rates on Direct Subsidized and Direct Unsubsidized Loans were their lowest at 3.4 percent between 7/2011 and 6/2013 and their highest at 6.8 percent between 7/2006 and 6/2008.

While federal loans are fixed, private loans may have adjustable rates. 

“We’re in a low-interest rate period right now, but if you’re planning on paying these back over the course of 10 to 20 years, you don’t know what the interest rates will be in the future which can make your loan payments unpredictable, “ Mai says.

Student loans aren’t free money; and they don’t come cheap, either, says O’Keefe. As an example, interest rates for buying a home right now are 4 percent or less, lower than any of the federal student loan interest rates.

Finance majors, you may already have this down. But for the rest of the class, listen up! 

Here’s how loan amortization works: You’re making a fixed monthly payment on the installment loan. A certain amount of the payment goes to the principal, which is the amount you actually borrowed, and the other amount goes to paying interest, explains O’Keefe. 

“In the early years, most of your payments are going towards paying off the interest,” she explains. “Amortization really just means that the interest is going to get paid first towards an installment loan and then whatever is left will go to the principal loan.”

There are lots of student loan calculators available online, and it’s definitely worth working with your financial aid office to help run the numbers that best fit your situation, which could vary widely depending on your loan types and terms. 

But, here’s a few scenarios taking into consideration the average debt load of $29,800 and factoring in a 5 pdf dng interest rate to show how much interest you could be paying. 

• If it takes you 25 years to repay, you’d be paying $22,462 in interest
• If it takes you 20 years to repay, you’d be paying $17,516 in interest. 
• If it takes you 15 years to repay, you’d be paying $12,618 in interest
• If it takes you 10 years to repay, you’d be paying $8,129 in interest
• If it takes you 5 years to repay, you’d be paying $3,941 in interest
• If it takes you 2.5 years to repay, you’d be paying $1,576 in interest

You won’t get charged extra for paying off your student loans early. So, if you can afford to make extra payments on your student loans, we’re cheering for you. 

Kantrowitz gives this scenario: 

Say you owe $30,000 at 5 percent interest with a 10-year repayment term. The monthly loan payment is $318.20. If you pay an extra $10 a month, you’ll pay off the debt four months early and save $314 in interest.

But, if you’re scrimping to get by and can’t be throwing extra Benjamins towards your payments each month, consider signing up for auto-debit so that your payment is auto-transferred from your bank to the lender. That way, you won’t pay late payments and you may even get a slight discount (reducing the interest rate by as much as 0.25 percent) as an incentive from lenders, Kantrowitz says.

We don’t blame you for wanting to avoid student loans. But, charging tuition on your credit cards is a bad idea, explains Chane Steiner, CEO of Crediful, a credit resource site. Plus, federal laws have made it harder for those under 21 to get credit cards.

For the current school year, the federal student loan interest rate is 4.53 percent for undergraduates, and even unsubsidized graduate student loans and parent loans are about 7 percent. But, Steiner says, credit cards can have interest rates as high as 30 percent. 

“Students still in school typically lack the income to pay down those balances, so they end up in a hole they can’t dig out of,” he says. “You don’t want to begin adulthood with excessive, unnecessary credit card debt.” 

On top of that, you can defer your student loan payments if you aren’t working or if you have a low income. But credit card companies don’t offer the same flexibility in terms of repayment, Steiner says. Whether or not you pay interest on your student loans while your loan is in deferment depends on your student loan type. In general, if your loans aren’t subsidized by the federal government, interest will accumulate while you’re in deferment, and then get tacked on to the total of the loan.

Your student loans will be on your credit report which lenders will review when you want to borrow money to buy a house or a car, explains Mai. 

“They’re also going to be looking at your income,” she says. “If you have too high of a debt-to-income ratio, they will limit or not let you borrow money for things like a mortgage or a car.” 

On the upside, your student loans can help you build your credit so long as you’re making on-time payments every month. On-time payments make up 35 percent of your FICO credit score. Also, creditors like to see a healthy credit mix of installment loans (like your student loans) and revolving credit (like your credit cards) and credit mix makes up 10% of your loans.

The fact that loan repayments aren’t due until after you graduate creates a little bit of an “out-of-sight, out-of mind” illusion surrounding student loans. But knowing how they work, and what you can expect when it comes to repaying them, will help set you up for financial success. If you have questions unique to your college-funding situation, set up an appointment with a financial aid counselor.