Guide to Student Loans« Back to Financial Aid Guide
Student Loans 101
To cover the cost of tuition and other educational expenses, most students consider taking out a student loan. Whether you're a first-time undergraduate, a graduate student, or a working professional seeking an online degree, there are a number of loan options available to you. This guide explains the basics of student loans from the federal government as well as private financial institutions.
Student Loans: Federal or Private
Student loans are available from two sources: federal loans from U.S. government-backed loan programs, and private loans from banks or other financial institutions. Federal loans are usually administered through your school's financial aid office. Many schools also offer private loans, or you can work directly with a lender to secure your own loan. In general, federal loans offer lower interest rates and easier repayment options, although private loans may offer higher borrowing limits.
Additionally, many schools offer financial aid programs and special payment terms for students of all ages and income levels.
For first-time college students, the first step in evaluating federal student loans is usually to complete the Free Application for Student Aid (FAFSA). After completing the FAFSA, you'll learn which federal loans and grants are available to you. The new FAFSA4caster program provides students with an early estimate of the amount of aid they're likely to qualify for, but keep in mind that submitting a completed FAFSA is the only way to be certain about the amount of aid available to you.
The FAFSA is a free form available through your school's financial aid office or online at http://www.FAFSA.ed.gov. Be wary of web sites that promise to complete the FAFSA for you in exchange for a fee - there's no need to pay anything to file a FAFSA, and it's not likely that you'll save any effort by using a fee-based FAFSA service.
Because of their lower interest rates, federal student loans are almost always the best option. However, private loans are a useful way for many students to fund their education. Some students obtain private loans because they are ineligible for federal loans. And many federal student loan recipients require private loans to cover the full cost of tuition. Several banks and financial services companies have developed private loan programs designed for students of law, medicine, and other expensive degrees.
Federal Loan Programs
The U.S. Department of Education offers three distinct student loan programs: Stafford, Perkins, and PLUS. Perkins and Stafford loans are disbursed based upon financial need, while PLUS loans are awarded based on creditworthiness.
Regardless of the federal loan program, all federal student loans share a few common qualities:
Regardless of the federal loan program, all federal student loans share a few common qualities:
- All federal loans must be repaid, even if the borrower drops out or changes schools. Some students incorrectly assume that repayment of federal student loans is contingent upon graduation. This is false. Just like defaulting on a loan from a bank or credit card company, failure to pay a federal student loan can result in damaged credit. Additionally, the government can even withhold tax refunds or take other action to recover defaulted loans.
- No payments are due while the borrower is enrolled in school
- Three repayment options are available for all federal loans:
- Standard repayment - fixed monthly payments for up to ten years
- Graduated repayment - a ten-year payment plan with smaller monthly payments at first, and larger monthly payments toward the end of the repayment period
- Extended repayment - fixed or graduated payments for up to 25 years
- Repayment of federal student loans, except PLUS loans, can be postponed due to deferment (typically granted if the borrower enrolls in school again) or forbearance (typically granted due to an inability to pay). However, interest will accrue during forbearance and (for some loans) during deferment.
- The total amount borrowed in federal loans cannot exceed the total cost of education minus other forms of financial aid - in other words, you can't borrow more than you really need. (But, remember that expenses like transportation and student housing can be included in the total cost of education.)
Once known as Guaranteed Student Loans, Stafford loans are awarded based on financial need and do not require a credit check. Stafford loans have a variable interest rate, capped at 8.25%. Current interest rates are 6% for subsidized Stafford loans and 6.8% for unsubsidized Stafford loans. For loan recipients who are in active military service, the interest rate is capped at 6%. Repayment of Stafford loans begins six months after graduation.
Subsidized Stafford loans are awarded based upon financial need. On subsidized Stafford loans, no interest is charged until repayment begins, and no interest is charged while the loan is in deferment. Because of the tremendous savings on interest, subsidized Stafford loans are a great deal, and any student who qualifies for a subsidized Stafford loan should strongly consider accepting it before taking an unsubsidized loan of any kind.
On unsubsidized Stafford loans, borrowers are charged interest as soon as the loan is disbursed. Unsubsidized Stafford loans have higher borrowing limits than subsidized Stafford loans. It's not uncommon for students to qualify for and accept both subsidized and unsubsidized Stafford loans in order to cover their expenses. The borrowing limit for Stafford loans - subsidized or unsubsidized -ranges from $3,500 to $20,500 per academic year. Borrowing limits are based upon the student's year in school, graduate/undergraduate status, and whether the student is considered a dependent on anyone's tax returns. Borrowing limits for undergraduates are typically between $3,500 and $5,500 per academic year.
Although all Stafford loans are made available by the U.S. Department of Education, some Stafford loans are actually funded by a bank or other private lender. Stafford Federal Family Education Loans (FFELs) are made by a bank and backed by the U.S. government, while Stafford Federal Direct Student Loans are funded directly by the government and administered through the school. The type of Stafford loan is determined by the school's participation in the William D. Ford Federal Direct Student Loan program -- participating schools (approximately 1,300 nationwide) offer Federal Direct loans, and students at non-participating schools will receive FFELs.
Federal Direct and FFEL Stafford loans offer the same interest rates and payment terms. FFEL borrowers have the ability to choose which bank funds their loan, and may be able to obtain slightly lower interest rates through bank programs like automatic payment or reduced interest rates for consistent on-time payment.
The Stafford Loan Forgiveness Program for Teachers offers significant loan forgiveness to teachers who meet the program requirements, including training in certain specialties and/or spending five years working in low-income schools.
Stafford loans provide low income borrowers with an income-contingent repayment option. Under this plan, monthly payments are calculated annually based on borrower's income; any unpaid loan amount after twenty-five years is cancelled.
Formerly known as National Defense Student Loans or National Direct Student Loans, Perkins loans are awarded based solely upon financial need. Perkins loans charge a flat 5% interest rate. All Perkins loans are subsidized, which means no interest is charged until nine months after graduation when repayment begins. All Perkins loans are administered through schools, and are funded by money from the U.S. Department of Education as well as loan payments from former students. Each school has a limited (and varying) amount of money available for Perkins loans, so interested students are encouraged to complete their FAFSA as early as possible. Undergraduates may receive up to $4,000 annually in Perkins loans, and graduate students may receive up to $6,000 annually. Actual loan amounts vary based on financial need, other financial aid sources, and total funds available at the school.
Perkins loan borrowers may be eligible for complete loan forgiveness - meaning no repayment is required - if they meet program requirements and are employed in certain vocations such as law enforcement, teaching, Peace Corps, or social work. Perkins loan forgiveness is usually administered through the school and requires proper and thorough documentation of the student's employment. For more information, consult your financial aid counselor.
Like Stafford loans, Perkins loans offer an income-contingent repayment for low income borrowers. Monthly payments are calculated annually based on borrower's income, and any loan amount remaining after 25 years is forgiven.
PLUS (Parent Loans for Undergraduate Students) loans are available to parents of dependent students. Unlike other federal student loans, PLUS loans are made based on creditworthiness, not financial need. Additionally, it is technically unnecessary to complete a FAFSA to obtain a PLUS loan - but completing the FAFSA is highly recommended, since it can uncover alternative and less expensive sources of financial aid.
Like Stafford loans, PLUS loans are available either through the school (if the school participates in the William D. Ford Federal Direct Student Loan program), or through a private lender as a Federal Family Education Loan (FFEL). FFEL and Federal Direct PLUS loans offer the same interest rates and payment terms. As with Stafford FFELs, borrowers are advised to consult their financial aid counselors when choosing a PLUS FFEL lender.
PLUS loans have a variable interest rate capped at 9%. Repayment begins 60 days after the school receives the funds. Most PLUS loans are repaid on a ten-year term, although it's possible to finance a PLUS loan for up to 30 years. Borrowers can elect to make interest-only payments while the student is in school.
PLUS loans for graduate students - also called GradPLUS loans - are also available, and are similar to PLUS loans, except that loans are made to students instead of parents.
Private student loans, sometimes called personal student loans or alternative student loans, are made by a bank or other financial institution. Generally, private loans will have higher interest rates and less favorable terms than federal loans. Some private loans may not even defer payments while the borrower is in school. Still, private student loans usually have better interest rates and payment terms than other lines of credit like credit cards or home equity credit, and therefore private loans are a viable option for many students. Private loans will require a co-signer unless the borrower has a solid and well-established credit history.
Almost every financial institution offers a credit product that could be considered a student loan. Many banks and other lenders have developed special student loans to cover the high cost of education for graduate, medical, and law students. Check with your financial aid counselor for recommendations, as most financial aid offices maintain a list of preferred lenders.
SLM Corporation, formerly the Student Loan Marketing Association and commonly known as Sallie Mae, funds many Stafford and PLUS FFELs and also provides private loans such as the Sallie Mae Smart Option Student Loan and the Signature Student Loan.
Originally a government-sponsored entity, Sallie Mae completely separated from the federal government in 2004. Today, SLM Corporation is a Fortune 500 company that operates several financial subsidiaries. Its subsidiaries include Nellie Mae, which specializes in funding FFELs.