So you've done everything you can possibly do to save on college costs.
You've searched for available scholarships and grants, you've applied for federal aid, and you've tried to pick an affordable school.
And you still have a college funding gap.
If I just described your situation, you're not alone. In fact, over 45 million people (and counting) have had to take out student loans to help pay for college. You shouldn't feel ashamed about needing to take out student loans. But you do need to be smart about the types of student loans that you choose.In nearly every case, you should begin with federal loans and only move to private loans if you've hit your federal funding cap. The only possible exception would be for some graduate students who are choosing between private loans and Grad PLUS loans. Once you've graduated, however, you may want to consider refinancing into a private loan. Just be sure to weigh the pros and cons.
Federal Vs. Private Loans
Before we get into specific types of student loans, let's talk about the general differences between federal and private loans.
Federal student loans come with several built-in benefits that private loans are unable to match. Some examples include the ability to make income-based repayments, the possibility of receiving student loan forgiveness, and generous forbearance and deferment rules.
The biggest advantage of private loans is that they could come with lower interest rates. But in order to qualify for great rates, you'll need to have an income and a good credit score–two things that most students don't have. For these reasons, it's hard to get approved for private loans without a co-signer.
The other advantage of private loans is that if you default on your loans, your lender can't garnish your wages unless they win a court judgment. However, the government can garnish wages on federal loans at any time without a court order.
So Which Should You Choose?
Nearly every borrower should begin with federal loans. And you should only move to private loans if you've hit your federal loans cap and need to bridge a funding gap. The payment flexibility and forgiveness options that federal loans come with are simply too good to pass up.
And (with the exception of Grad PLUS loans), the interest rates on federal loans are already fairly low. Virtually no students will be able to land a better interest rate on a private student loan without a co-signer.
Let's take a closer look at each of the federal student loan types that are available today.
Direct Subsidized Loans
Whenever possible, you want to begin with Direct Subsidized student loans. When it comes to interest rates and origination fees, they come with the exact same terms as Direct Unsubsidized Loans. Both come with a 4.53% interest rate (for the 2019-2020 school year) and a 1.059% loan fee.
But where subsidized loans really shine is in how they handle student loan interest. With Direct Subsidized Loans, the Department of Education will pay the interest on your loans in certain situations. Those situations are:
- While you're enrolled in school (at least part-time)
- During your 6-month grace period
- During a deferment period.
The downside to Direct Subsidized Loans is that you might not qualify for them. In order to receive a Direct Subsidized student loan, you'll need to demonstrate financial need. And your school decides how much you're able to borrow based on your specific financial situation and any other aid that may be available to you.
Also, Direct Subsidized loans are only available to undergraduate students. So if you're working on your master's or doctorate degree, you'll be left out in the cold.
Finally, Direct Subsidized loans come with fairly low borrowing limits. For instance, in your first year of college, you can borrow no more than $3,500 in subsidized student loans. And throughout your entire undergrad program, you can borrow no more than $23,000 in Direct Subsidized Loans.
Direct Unsubsidized Loans
Direct Unsubsidized Loans are the best choice for anyone who doesn't qualify for subsidized loans or who have reached their subsidized loans borrowing cap.
With Direct Unsubsidized loans you do not need to demonstrate financial need. That's their biggest advantage. But the biggest disadvantage of unsubsidized student loans is that you're responsible to pay the interest during all periods.
Direct Unsubsidized Loans also come with higher annual borrowing caps. For instance, independent undergrad students can borrow up to $9,500 in subsidized loans in Year 1. In total, undergraduates can borrow up to $57,500. And graduate students are eligible for Direct Unsubsidized Loans, up to $20,500 per year.
Direct PLUS Loans
There are two types of Direct PLUS loans – Parent PLUS and Grad PLUS. Direct PLUS loans are unique in that they don't have a fixed borrowing limit. Instead, you can borrow up to the cost of attendance.
But the downside to Direct PLUS loans is that they have, by far, the worst terms. Currently, the interest rate on Direct PLUS Loans is 7.08% and the loan fee is a whopping 4.248%.
Direct Consolidation Loans
As you go throughout school, it's common to accumulate quite a collection of federal student loans. You could easily end up with 5-10 federal student loans or even more.
It can be really difficult and confusing to stay on top of the repayment schedules for that many student loans. To simplify things, the Department of Education will allow you to consolidate all of your separate federal loans into one through a Direct Consolidation Loan.
This can certainly help you manage your student loans. But it's important to point out that you can't lower your interest rate during loan consolidation. The rate you get will be the weighted average of the interest rates on all your loans being consolidated, rounded up to the nearest one-eighth of one percent.
Also, if you've been working towards Public Service Loan Forgiveness (PSLF) or Income-Driven Repayment forgiveness, you will lose credit for all payments that were made before the consolidation.
For these reasons, it's usually best to consolidate your loans right before you begin repayment. But if you've already been repaying for several years, you may be better off just dealing with the hassle.
Perkins and FFEL Loans
Both of these types of student loans are no longer available. FFEL Loans were discontinued in 2010 and Perkins Loans in 2018. But if you graduated a few years ago, you could have one or more of these.
FFEL Loans do qualify for the IBR income-driven repayment plan. But if you want to join the PAYE, REPAYE, or ICR plans, FFEL Loans are only eligible via a Direct Loan Consolidation. Perkins Loans are ineligible for all income-driven repayment plans (including IBR), but can become eligible through a Direct Loan Consolidation.
Perkins Loans and FFEL Loans are both ineligible for PSLF but can become eligible if you consolidate them via the Direct Consolidation Loan program.
There are three main types of private loans–undergraduate loans, graduate school loans, and refinanced loans. Let's take a closer look at all three.
In order to qualify for an undergraduate private loan, you're typically going to need a co-signer. For this reason, you should avoid undergraduate private loans unless you absolutely must take them out.
The only time that an undergraduate private loan may be worth considering would be for profession-specific loans that come with special terms. An example would be the HRSA loans that are designed for students who are pursuing a career in healthcare.
If you do decide to take out undergraduate private school loans, make sure to shop around for the best deal. And while the interest rate you get is important, it's not the only factor to keep in mind. You'll also want to consider things like payment flexibility and forbearance or deferment options.
As with any industry, some private lenders are better than others. The best private lenders will typically let you choose from four repayment options while you're still in school:
- Full deferment: This will cause the most interest to accumulate during school and capitalize when you begin repayment.
- Fixed monthly payment: $25 is a common amount. This repayment plan will help you accumulate a little less interest during school.
- Interest-only payment: Your monthly payment will be a bit higher but you won't accumulate any interest during school.
- Full payment: Full monthly payment of the principal plus interest while you're in school
Pick whichever repayment plan you can afford while also minimizing interest accumulation. Also, try to find a private lender that offers financial hardship forbearance and/or academic deferment on its student loans.
Graduate School Loans
Depending on your career choice, you may be able to qualify for a private loan for graduate school on your own. Private lenders tend to only allow this for graduates who are earning degrees in fields that are known for providing high salaries.
Here are a few examples of the kinds of students who may be able to qualify for graduate loans without a co-signer.
- Medical school students
- MBA students
- Dental school students
- Pharmacy school students
- Optometry school students
But just because you can qualify for a student loan, doesn't necessarily make it the right choice. Personally, I wouldn't choose a private grad loan over a Direct Unsubsidized Loan.
But should you choose a private graduate school loan over a Grad PLUS Loan? In some cases, that may be worth considering.
As mentioned earlier, Grad PLUS loans come with high-interest rates and origination fees. So if you've hit your annual Direct Unsubsidized loan limit ($20,500 per year), a private graduate school loan could be a smart move if you're offered an attractive interest rate.
But if you plan to pursue Income-Driven Repayment (IDR) or PSLF, you'll want to stick with Grad PLUS Loans, despite their unfavorable terms.
After you graduate and begin your career, you may qualify for a better interest rate by refinancing. In the right situation, refinancing could save you a ton of money in student loan interest.
For example, let's say you graduated with $50,000 in student loans with an average interest rate of 6%. You'd pay over $16,000 in student loan interest over the life of your loans.
Image credit: Bankrate student loan calculator
Now let's say that you were able to refinance into a private loan at 3.5%. In that case, you'd save over $7,000 in interest.
Image credit: Bankrate student loan calculator
That's a big deal.
But in order to qualify for the best rates, you'll need to have a good credit score and a healthy income. And your debt-to-income ratio will need to be reasonable. If you owe more than twice your annual income, you'll probably have a hard time qualifying for refinancing.
And it's important to point out that you'll lose out on the federal benefits mentioned earlier.
So if you're worried that you may suffer an income drop in the near future, you'll probably want to stick with federal loans since they offer income-based repayment. And if you work for the government or a non-profit and you're pursuing PSLF, you should definitely not refinance.
There are a lot of pros and cons to refinancing student loans and you need to consider them carefully before making a decision. And if you decide that refinancing is the right move for you, make sure to compare rates using a comparison shopping site like Credible.
No one wants to graduate with student loans. But the odds are high that most of us will.
If you do need to take out student loans to pay for your education, always pick the loans that give you the best terms and flexibility for your situation.
For most students, federal loans are the way to go. But once you've achieved some career stability, refinancing into a private loan could be a smart financial decision.
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