Using Student Loans to Finance the High Cost of Student Loans

According to the National Postsecondary Student Aid Study, sixty-six percent of all undergraduate students received some sort of financial aid for the 2013-2014 school year and thirty-eight percent took out an average of $7,100 in student loans. Parents of some of those students borrowed an average of $10,800 in Parent PLUS loans. Borrowing those amounts over a period of four or five years adds up to a heavy debt load for a new graduate. Students should carefully explore all available sources of financial aid and realistically assess their ability to repay any loans.

Federal Student Loans

Federal loans offer the best deal. The government charges lower interest rates than private lenders and most federal loans don’t require a credit check. Federal student loan interest rates are the same fixed rate for all loans made under the same program (e.g., subsidized, PLUS) for a particular disbursement period.

The Department of Education’s Federal Direct Loan Program options include subsidized loans, unsubsidized loans, and PLUS loans. Subsidized loans are made based on financial need and don’t accrue interest while the borrower is in school, during the grace period after graduation or during deferment periods. Unsubsidized loans don’t require a demonstration of financial need, but interest is charged from the time the loan is made. Parents and graduate students can obtain PLUS loans if they meet the program’s credit underwriting criteria. Like unsubsidized loans, PLUS loans do not include any interest free periods.

Prior to 2010, the federal loan program allowed private lenders to originate federally guaranteed student loans. The Student Aid and Fiscal Responsibility Act made the Federal Direct Loan Program (“FDLP”) the sole source of all federal student loans.

Private Student Loans

Because they lack a payment guarantee from the government, private lenders charge higher interest rates than FDLP loans and borrowers must satisfy credit and other underwriting requirements. Private student loan interest rates are determined by adding the prime rate or LIBOR to a risk margin based on the borrower’s credit rating. Students (and their parents) should avoid private student loans unless savings, scholarships, grants and federal loans won’t pay all education costs.

Student Loan Consolidation and Repayment

After graduation, federal loan borrowers have ten years to pay off their loans with either fixed equal monthly payments or graduated monthly payments that increase every two years. Those with more than a minimum total amount of Direct Loan debt  can qualify for a twenty-five year extended repayment term.

FDLP also offers an income contingent repayment plan that calculates payments based on the borrower’s adjusted gross income. Some borrowers can even get a discharge of any remaining debt if the income contingent repayment plan payments are not sufficient to pay off the loan within 25 years.

A federal loan consolidation combines one or more federal loans into a new loan. The monthly consolidation loan payment may be lower than the total of the monthly payments on the loans before consolidation. Unfortunately, the Direct Loan Program will not consolidate federal loans with private loans.

For private loans, repayment terms usually range from ten to twenty-five years. Some lenders allow students to defer all payments of principal and interest until six months after graduation. Other loans collect interest only payments while the borrower is enrolled in school or require immediate principal and interest payments.

Advanced planning, research and budgeting can help students avoid surprises and undue hardship after graduation. The Direct Loan Program and other sources publish resources to help with the process. Many websites also include a student loan repayment calculator that estimates future monthly payments.