- Student Loans
- Student Loans are loans taken out to finance an individual’s education. Student loans are considered “good debt” because they can increase a person’s overall earning power over time. Student Loans can be obtained from both the federal government and private lenders.
What are Student Loans?
People take out student loans in order to cover the costs of a college education. There are two main kinds of student loans: federal loans and private loans.
Federal loans are offered by the US Department of Education. Loans for undergraduates are commonly referred to as “Stafford Loans.” There are also Direct PLUS loans for graduate or professional students and Federal Perkins loan for students who display exceptional financial need.
Private loans, on the other hand, are issued by a wide variety of private lenders, including most major banks. Private loans can also be issued by credit unions, state agencies, or by the school themselves.
Federal Loans generally come with more protections and lower interest rates than private loans.
How does applying for a Student Loan work?
When a person is applying to a college, they will usually out the Free Application for Federal Student Aid (FAFSA). Colleges use that form to determine how much of the educational costs that a person (and/or their family) can afford to pay.
The school will then send them a Financial Award Letter that will include the total cost of their education, the student’s expected contribution, and the amount of financial aid that the student will receive. Depending on the student’s circumstances, that letter might include federal student loans that the student has qualified for.
With private student loans, the student will have to apply for them separate from their application to the school. While federal loans do not require a cosigner, most private student loans do.
What is a cosigner?
With student loans, the cosigner is usually the student’s parents, as many younger students do not have the creditworthiness to be approved for a loan from a private lender.
What are the differences between Federal and Private Student Loans?
The two main differences between federal and private student loans are cost, terms, and availability.
Generally, federal student loans come with lower interest rates and with more favorable terms and protections than private student loans. However, private loans are also much more widely available than federal loans and are necessary for many students if they are to pay for their education.
The average interest rate for a federal student loan is in the range of 3-6 percent, depending on the loan-type. With federal Perkins loans, there is no interest charged. The borrower is only responsible for paying back the principal amount borrowed.
On the other hand, interest rates for private loans can be above 18 percent in some cases. Private Student Loans can also have variable interest rates, where the interest rate goes up and down over the life the loan. The interest rates for Federal student loans are fixed, which means they do not change.
Federal Student Loans do not require a cosigner, whereas the majority of private loans do. Federal student loans also come with a wide variety of repayment plans, some of which are income-based. They generally offer more flexibility than the repayment plans for private Student Loans.
While both federal and private loans will accrue interest while the borrower is enrolled in their school, federal loans do not require repayment until after the student has graduated, left the school, or changed their enrollment to under half-time. This is referred to as “deferment.” People with outstanding Federal Loans can also apply for deferment in certain other circumstances, such as when they temporarily unemployed, serving active military duty, or pursuing approved areas of graduate study.
Deferment is not applicable private loans, which generally require that the borrower (or the cosigner) make payments on the loans while they are still enrolled, unemployed, in the military, etc.
Lastly, federal student loans have more options for loan forgiveness than most private loans, which are very difficult for borrowers to discharge. To learn more about the options for Federal Student Loan forgiveness, please read this entry from the Federal Student Aid website. Private Student loans are almost impossible to get forgiven.
What are the different kinds of Federal Student Loans?
There are four different kinds of Federal Students Loans: Direct Subsidized (Stafford) Loans, Direct Unsubsidized (Stafford) Loans, Direct PLUS Loans, and Perkins Loans.
- Direct Unsubsidized (Stafford) Loans: These loans are available to both undergraduate and graduate students and are determined by the school in which the student is enrolled. During periods of deferment, these loans continue to accrue interest the student is responsible for paying off.
- Offered to undergraduate students, the awarding of these loans are determined by the school in which the student is enrolled. The federal government pays the interest on the loan during periods of deferment and also during a six-month grace period after the student leaves school.
- Direct PLUS Loans: These are offered to graduate or professional students who are enrolled at least half-time in a graduate or professional degree-granting program. They are also available to parents whose dependents are enrolled at least half-time in an undergraduate program.
- Perkins Loans: Available to both undergraduate and graduate students who display exceptional financial need, these loans come with a 0 percent interest rate. Through the Federal Perkins Loan Program, the borrower’s school actually serves as the lender. Repayment is then made to the school, not to the federal government.
Why are Student Loans considered “good debt?”
Student Loans are considered “good debt” because they allow the borrower to receive a college education. Theoretically, that college education will increase the amount of income that the borrower will be able to earn in their lifetime.
Good debt is any kind of debt that is seen to increase a borrower’s total net worth or potential for net worth. Mortgages are considered to be good debt because they allow people own homes, which usually will increase in value over time.
Bad debt, on the hand, is debt that decreases a borrower’s total net worth. Consumer debt is the most common kind of bad debt. Using a credit card to purchase items like food, clothing and home furnishings or electronics does not increase a person’s net worth as all of those items will generally decrease in value over time.