Paying Student Loans 101
You may have been told that student loans are an investment in your future, but that doesn’t mean you want to keep paying them forever!
With nearly 70% of college grads paying off student loans, the need for understandable student loan information is greater than ever. Unfortunately, it’s not always easy to know what to do about monthly payments that can range from $50 to $1,000 or more, especially in this uncertain economy.
If we had a dollar for every time we at LearnVest heard the words, “I wish I had known about …” from a student-loan holder, we might have enough to pay off a student loan or two! So read up on the ins and outs of paying off student loans, from how to save money on them to crucial differences in student loan types.
Paying Student Loans in a Nutshell
Like car loans and home loans, student loans are borrowed money that you are legally obligated to pay back to the lender, whether it’s a government entity or private lender. One feature of student loans is that for most loans, but especially federal ones, the interest rate is lower than the rate on debt like credit cards or car loans and is considered an investment in your future, making it “good” debt. In most situations, you can and should prioritize paying off any “bad” debt you have first while paying the minimums on your federal or low-interest private loans. (Read more about the difference between federal and private loans here.)
Why Understanding How to Pay off Student Loans Is Important
Don’t let the above information make you casual about your student loans, however. What makes student loans unique is that they are very rarely dischargeable in bankruptcy, so you will be responsible for eventually paying them off no matter your financial situation. There are also harsh punishments–financial and otherwise–if you fall behind or default on your student loan payments.
By learning everything you can about how the student loan system works, you can pay back your student loans responsibly, without wasting unnecessary money on fees and interest or stressing yourself out.
Understand Your Student Loan Type
It’s important to understand what kind of loan you have, because that will affect how best to handle repayment, how much your loan will cost you and more.
|Types of Student Loans|
|Direct Subsidized Loans and Subsidized Federal Stafford Loans (a.k.a. subsidized loans)||The benefit of subsidized loans is that the federal government pays the interest on them while you are enrolled at least half-time in school, during the six-month grace period after you graduate (during which you don’t have to make payments on your loan) and during deferment periods.|
|Direct Unsubsidized Loans and Unsubsidized Federal Stafford Loans ( a.k.a. unsubsidized loans)||You are responsible for paying the interest on unsubsidized loans starting from the date you received the loan–whether it’s during your grace period, while you’re enrolled or while it’s in deferment.|
|Direct PLUS Loans and Federal PLUS Loans (PLUS loans)||These loans are for graduate or professional degree students or for parents of dependent undergraduate students. Like unsubsidized loans, you are responsible for paying the interest on PLUS loans from the date you receive the loan, regardless of whether you’re in a grace period, enrolled or have them in deferment.|
|Federal Family Education Loan||This FFEL program halted giving out student loans in 2010, but it’s very possible you have a holdover. FFEL loans were given by private lenders, but backed by the federal government, with the same repayment options and protections as federal loans.|
|Private loans are governed under a different set of rules (mainly the lenders’ own rules) than federal loans. They can come from banks, schools, non-profit institutions or other lenders. Note that while Sallie Mae is technically a government-backed entity, loans through this lender function as private loans.|
Not sure what kind of student loan you have? You can look yours up in the National Student Loan Data System (NDLS) using your Social Security Number, your date of birth and your PIN, provided to you by the Department of Education. If you don’t know your pin, you can apply for one here. If you don’t see yours in the database, it is probably a private loan.
Loan Principal: This is the initial amount you borrowed, which doesn’t include interest you’ve been charged. For example, if you take out a loan for $10,000, the principle is $10,000. You might owe more to the lender, however, because of interest charged over time.
Interest: What you “pay” for taking out the loan. Interest–ranging from 3% to 18% of the loan–is calculated daily and added to the balance of what you owe the lender. The longer you take to pay back the loan, the more interest you will pay overall.
Grace Period: For certain federal student loans, the six-month period after graduation or after dropping below half-time enrollment before a borrower must start making payments.
Consolidation: Combining several loans into one loan requiring one monthly payment. Often consolidation spreads out repayment of all the loans over a longer period of time.
Capitalized Interest: Interest accrued during a period when a student loan holder isn’t required to make payments–either because she is in school, the student loan is in the grace period or deferment. It is added to the principal of the loan.
When You Have to Start Paying Loans Back
The good news is that, as of 2008, you can pay off as much of your loans as you want early, with no penalty, whether they are public or private. You can also request a shorter payment schedule. Doing either of these things will save you money, because you will accrue less interest.
If You Have Subsidized Federal Loans
For those of you thinking, “Pay it off now? I don’t even have a job!”, there’s more good news. For most federal loans, you have a grace period of six months from the time you graduate or drop below half-time enrollment in school before you need to start repaying your loans, during which the government is paying your interest. You have 45 days after the grace period ends to make your first payment. (If you have a PLUS loan, you do not get a grace period.)
We recommend: Making payments once the grace period is over on your loans.
If You Have Private or Unsubsidized Loans
For unsubsidized loans and private loans, the interest starts accruing as soon as the loan is disbursed, or given to you or your education institution–yes, that means before you even graduate. You are immediately charged interest every day, and then that cost is added to the principle of the loan (in lender speak: “capitalization”). Then you’ll be paying interest on interest–you can see how this can snowball into your owing more and more.
We recommend: If you have an unsubsidized or PLUS loan, you should start trying to pay down your loan as soon as you have the money to do so. You can save thousands. For example, if you have a $15,000 loan, and let the interest accrue over a year, you’ll owe $1,185 extra on the principle of your loan.
How Much Interest You’ll Pay
Interest rates vary according to the type of loan you have and when you took it out:
- For federal loans given after July 1, 2006: The interest rate is fixed, meaning it will never change. It can range from 3.4% to 6.8%.
- For federal loans given before 2006: The interest rate is variable–it changes every year on July 1st. For subsidized and unsubsidized loans given before 2006, the interest rate can never go above 8.25%, and for PLUS loans it can never go above 9%. (To give you some perspective, credit card interest rates range from 9% at the low end, up to 25%.)
- Private loans: Private loans typically have variable interest rates, and they’ve been known to go as high as 18%, though as of 2012, variable interest rates are low.
To calculate the monthly interest charge to you for your federal loan, use this equation:
[Average daily balance between payments] x [the loan interest rate] x [number of days between payments/365.25)]
So if you have a $10,000 loan with an interest rate of 6.8%, and you want to know the interest charged in September, which is 30 days, that calculation would look like this:
$10,000 x .068 x (30/365.25) = $55.85
Interest is charged on a daily basis for student loans, so you could see your balance increase a little bit each day. As you’re paying off your student loans and get down to the last payment for each one, use the above calculation to determine how much extra you should tack onto your check so that by the time it arrives, you will pay off the entire thing, and not leave yourself a few dollars to pay. Some lenders also do this calculation for you.
All About Repayment Plans
If you don’t communicate with your federal lender, you’ll be automatically enrolled in a standard payment plan (see below). But you actually have other options for federal loans, depending on how many years you want to have to pay your loans off, plus what your income looks like. Overall, the most important thing to keep in mind is that the lower you make your monthly payments and the longer you take to pay off your loan, the more you will pay in interest over the lifetime of the loan.
If you decide to consolidate (we walk you through the pros and cons here) then you’ll also be asked to choose a new repayment plan from the ones below.
Standard Repayment Plan: You pay a fixed amount of at least $50 a month for up to ten years. This is the option which is the best value for you (aside from just paying off your loan right now), as you will pay the least interest over the life of the loan.
Graduated Repayment Plan: Best for people who have a low income now but expect it to gradually rise, payments start out low and increase every two years. You have up to ten years to pay. Because interest is accumulating faster in the early years, you’ll pay more overall for your loan under this plan than under the standard plan, because for the first few years, you are essentially just paying interest instead of paying off the loan itself. If you are in this type of plan and you don’t send more than the interest you owe every month, then you are not getting any closer to paying off your loan–you’re just paying to have the loan not go into default.
Extended Repayment Plan: If you have more than $30,000 in DIRECT or FFEL loans, you could qualify for the extended repayment plan, which gives you 25 years to pay off your loans. Note that if you have both DIRECT or FFEL loans, but hold over $30,000 in only one type, you can get the extended repayment plan for only that type. For example, if you have $40,000 in DIRECT loans and $25,000 in FFEL loans, you can only apply the extended repayment program to the DIRECT loans. While your monthly payments will be lower–because you are spreading out repayment over a longer period of time–you’ll also pay more in interest over the life of the loan.
Income-Based, Income-Sensitive or Income-Contingent Repayment: These repayment plans really only differ in which kind of loans they apply to. Your payment is capped at a number that is affordable to you based on your income. The repayment period is up to 25 years. If by then you still have a loan balance, it could be forgiven (but you may have to pay income tax on the forgiven portion).
An Income-Based Repayment plan is an especially good choice if you are enrolled in program for people working in public service or teaching jobs that forgives your loans after 10 years, called Public Service Loan Forgiveness (PSLF). This will keep your payments affordable until that time when you can stop making them altogether!
Consider carefully which payment plan you want! Your decision could cost you tens of thousands of dollars. For example, let’s say you graduate with $100,000 in student loans (not unheard of). If you choose the extended graduated payment option, which spreads your loan payments out over 25 years and starts them out small, you could end up paying back more than $225,000 in total.
Your repayment options vary for private loans, and some private lenders don’t offer any other repayment options other than the standard one. You should contact your private lender to find out if you have options.
Which Loan to Pay Off First
If you have private student loans, focus on paying those off first while making minimums on your federal loans. There are two reasons for this:
- In 2012, interest rates are low, but because most private loans have variable interest rates, your private loan could–and most likely will–rise in the future.
- Private lenders aren’t obligated to work with you in financial duress, while federal loan servicers are. If you get hit with a job loss or other financial emergency, having your private loans paid off and only federal loans remaining gives you more flexibility with payments.
After you pay off your private loans, you should order your remaining federal loans from highest to lowest interest rate, and focus on paying the high-interest loans off first.
If you don’t understand something or are having trouble with your payments, don’t hesitate to contact your loan servicer. Read all communications from your loan holder and keep all your records pertaining to your loans in a safe place. Prioritize making your payments on time and in full. It’s challenging, but you’re up for a challenge. After all–you went to college.
More Student Loan Resources:
The definitive website for information on federal loans: nslds.ed.gov
Loan consolidation for DIRECT loans: loanconsolidation.ed.gov
Apply for a PIN to look up your federal loan records: pin.ed.gov
Income based repayment: www.studentaid.ed.gov
If you suspect your private lender is acting illegally: www.consumerfinance.gov/