Complexity of Student Debt

Key Takeaways

  • It’s important to know your options in choosing a loan to fund your education as there are big differences between federal and private loans.
  • Federal loans have several flexible repayment options whereas private loans do not.
  • Paying your first loan payment on time and in full helps build your credit and keep it high so you can reduce interest expense on other loans.

Student debt can be confusing as there are several types of loans, and different ways to pay them off. It’s important to understand that there are federal loans and private loans, and that there is a lot more flexibility using one versus the other. image-1

The different types of federal loans are:

Direct Subsidized Loan – You would apply for this if you have financial need and you are applying to an undergraduate program. The amount you can borrow is determined by your school and it can’t exceed your financial need. The U.S. Department of Education pays the interest on your loan while you are in school and up to six months after graduation.

Direct Unsubsidized Loan – This is available to undergraduate and graduate students. You do not have to show financial need. The amount you can borrow is determined by your school and is based on other financial aid you receive and the cost of attendance. You pay the interest on the loan.

Direct PLUS Loan – This loan is available for graduate or professional students, or to parents of a dependent undergraduate student. You can’t have a bad credit history if you apply for this loan (and if the parent is applying, the dependent can’t have bad credit either). The amount you can borrow is the cost of attendance minus other financial aid you receive.

Perkins Loan – This type of loan is available to undergraduate, graduate and professional students that have a very high level of financial need. The interest rate is kept low at 5%, but not all schools participate in this program. The loan is funded by the school you attend, so there is a limited amount of available funds.image-4

You don’t need to start paying on these loans until 6 months after graduation and at that point, it’s a 10-year period to pay them off. All of these loans are administered by the U.S. Department of Education who assigns 1 of 10 service providers for the loan.

When it comes to repaying your federal loans, the government has a few options in stretching out the repayment:

IBR (Income Based Repayment) – Typically 10% of your income over 20-25 years and geared towards graduates in lower salaried positions.

PAYE (Pay As You Earn) – 10% of your income over 20 years if you are a “new borrower” which is any borrower after July 1, 2014.

REPAYE (Revised Pay As You Earn) – 10% of your income over 20 years if your loans are for undergraduate education, and over 25 years if the loan is for graduate or professional education. This option is available regardless of when a person borrowed, unlike the PAYE option.

PSLF (Public Student Loan Forgiveness) – Geared towards specific jobs within the public sector and tax-exempt, not-for-profit organizations. Loan forgiveness happens in 10 years.

For all of these repayment plans minus the PSLF, the loans are forgiven at the end of 20-25 years, but there may be some tax consequences.

If those repayment options don’t work, you can go to your service provider and ask for a deferment. Depending on your reasons for requesting a deferment, you can qualify for up to 3 years. If you don’t qualify for deferment, you can apply for forbearance which lets you stop payments or reduces them for up to 12 months.image-2

We’ve covered the federal loans so let’s switch to private loans.

You apply for private loans from Sallie Mae or from financial institutions. These loans:

  • Have higher interest rates than federal loans
  • Normal underwriting process, which means you may need a joint signer
  • No forbearance
  • No deferment
  • No stretch out programs
  • Not bankruptcy dischargeableimage-3

You have to pay these loans over the time-frame agreed upon by you and the institution at the time of getting the loan, so these are very strict, no room for error loans.

Make your first payment on time for your student loan and automate the other payments. This will keep your credit score high, which reduces interest expense on auto loans, home loans, and credit cards.

Until next time, enjoy. Gary

Please note: I reserve the right to delete comments that are offensive or off-topic.

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