It’s no secret that a college education is very expensive. Unless you can get a scholarship or money from your parents, a loan is the only option you’ve got left. With that in mind, how do you proceed? There’s no need to wonder anymore because we’ve got the perfect, little explanatory guide for you, prepared to answer the question how do student loans work.
The most important thing you need to know about student loans is that there are several types. Some of them stem from financial need, while others are no different from a traditional loan. This aspect means they will be based on your credit score. Still, there are two things they have in common.
- You will have to pay them back at some point. This bit of information might sound redundant as you read this, but you will be surprised to learn how many people there are who are essentially wondering if they will have to give the money back or not.
- The student loan will amount to tens of thousands of dollars over the year. Translation? Be prepared. If you are a freshman, and it all seems remote now, there will come a time when you have to face facts and give every single penny back. And when you do, we’re talking major bucks.
This brings us to one, crucial tip – be as frugal as you can during your college years. Remember that the more you borrow, the more you will have to give back. The best thing to do is to ask for as little money as you can and live off it. It will be tight, but future you will thank you a thousand times.
How do student loans work?
That being said, without further ado, here are the types of student loans about which you need to know.
#1. Student loans issued by the federal government
The number one reason why these types of loans are a lot more attractive to students than all the others is the fact that The state issues them. This means low and fixed interest rates. However, even though that sounds as good as it gets if you’re planning on learning more on our predicament, how do student loans work, you need to know they have some downsides as well.
For example, one of these disadvantages is their availability. Some federal student loans, such as the Perkins loan, are based on need. This translates into the fact that, even if you need the loan as much as the next guy, you might still not get it if the government decides your household’s gross income is too high.
Another disadvantage is the fact that federal loans typically come with a borrowing limit. This, evidently, means there is only so much money you can borrow. In the last few years, the limit was around $30 000. If this amount is not sufficient for your needs, you should plan your finances very well and use the federal loan as a bridge that can close the gap between fees and tuition and grant money and scholarships.
#2. Private and alternative loans
Continuing on our path to finding out ‘how do student loans work, the other option you need to know about are private loans. To put it as simple as possible, these are the loans you can get from private companies, such as banks and other financial institutions. Just the same as with the federal loans, there are both pros and cons to going with a bank.
As far as pros go, here are some of them.
- They can offer some deferments, typically after you graduate, of up to six months. A deferment is a period when you are allowed not to pay your installments, for different reasons.
- Banks offer automatic debit from your account, which is an advanced feature based on the fact that they have been in the business of lending money a lot longer than the federal government has.
- The best part of private lenders offer you deals such as a quarter percentage point off your monthly interest rate because it will save them some money ultimately.
Here are the cons to borrowing from a private lender, as opposed to the federal government.
- It’s difficult for a student to be considered eligible. The fact that you have no job or other sources of income means you cannot guarantee that you will pay your monthly installments. In the same way, seeing as you have no assets to your name, such as a house, will again, not ensure the bank it will get its money back. Therefore, they might not grant you the loan.
- Whether you receive the credit or not will, consequently, be based on your creditworthiness. The bank assesses how creditworthy you are by looking at things like whether or not you paid your parking tickets, your bills or your rent. If everything is in order, you will get the loan, even if you don’t have a marvelous credit score, by traditional rules.
If you are not considered creditworthy enough, then you won’t get the credit. Even so there is still something you can do. If you are able to find a cosigner, then the financial institution or bank will grant you the loan nonetheless.
A cosigner is a third party who agrees he or she will pay the installments every month should you prove unable to do so. A cosigner is usually a parent, another close relative or a friend.
The final point of our little explanatory guide that tries to answer the question how do student loans work? is the repayment.
As far as private loans go, you have three options for repayment:
#1. Full deferral – offers you the chance of delaying your payment altogether for six months after you graduated. However, it’s crucial you remember that, even so, interest will still build up. The sum will be then added to the original amount of money you had to pay.
The very good news in this case, though, is the fact that you will be able to deduct up to $2500 out of that interest every year on your taxes.
#2. Immediate repayment – this type is pretty self-explanatory. Within 45 days after you enroll, you will begin to pay back the money you borrowed. As a pro, this method doesn’t allow interest to build up.
#3. Interest only payment – This type asks you to start making payments while you are still in college, but only on the interest. This method keeps the interest from building up as well and lowers your monthly payments.
When it comes to federal loans, the repayment structure is a bit different. Even though you are still granted a deferral if you want it, the same as for private loans, the repayment terms are much more attractive.
#1. Standard and extended repayment plans – They work in the same way, only that the first one spans over ten years, while the second over 25.
#2. Graduated repayment – is a 10-year repayment method where you begin with low monthly fees and slowly build your way up. It was specifically designed to parallel the way your salary will increase as times goes by.
#3. Income-based repayment – It extends past 25 years, and the extraordinary thing about it is that, after 25 years of constant paying, what is left over might be granted forgiveness by the lender.
#3. Income contingent plans – It’s calculated every year based on your income. It revolves around the idea that the monthly installment shouldn’t go above 20% of said income. This plan extends over a period of 10 years.
Getting a student loan is no easy task, as you might have noticed. First of all, it can be quite challenging to get one and, secondly, it will take a lot of time to repay it. But as long as you have our trusted how do student loans work explanatory guide by your side, you’re good to go!