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Student Loans Done Right: Part 1

Borrowing money for post-high school education has mushroomed into an alarming national financial crisis. Americans owe $1.5 trillion and growing in student loan debt. Yes, that’s trillion with a t. Student loan debt has shot past credit cards and auto loans as the second highest form of consumer debt, second to mortgages. 

Financial planning prevents you from becoming a part of this scary statistic. If you or a loved one is navigating the complex maze of student loan options, know that it is possible to emerge financially intact after receiving your hard-earned degree. Armed with the right information, you can create a realistic plan to make education an asset, instead of a drain on your financial future. 

Let’s kick off this two-part series with how to choose the loan that’s right for you. 

What kind of student loan should I take?  

Student loans issued by the U.S. Department of Education (ED) carry less risk and more protections than private student loans issued by a bank, credit union, or other lenders. 

The advantages of a federal loan include: 

  • Lower fixed interest rates. A fixed rate does not change over the life of the loan. 
  • Limits on how high-interest rates can be set. 
  • More borrower protections, repayment options, and opportunities for forgiveness (more on these in Part 2). 

A private loan almost always has a higher fixed interest rate than a federal loan, some as high as 13%. Many private lenders also offer loans with a variable interest rate. That means the rate fluctuates up or down over time in step with prevailing interest rates in the financial market.  

A variable rate often starts out lower than the fixed rate on a federal loan. That can save you money if you know you can pay off the loan quickly—in five years or less. Otherwise, beware. Even when the variable rate is capped, the ceiling can be as high as 25%. 

If you can’t afford the risk, exhaust all options for scholarships, grants, work-study programs, and government loans before considering a private loan. 

What are the characteristics of different federal student loans? 

Loans guaranteed by the U.S. government include: 

Direct Loans 

Uncle Sam lends the money and guarantees the loan. 

Subsidized direct loans – Available to undergraduates with financial need. The school determines the amount you can borrow, which can’t exceed your financial need. Interest does not accrue while the student is in school, for the first six months after leaving school (the “grace period”), or during a deferment (a postponement of loan payments). 

Unsubsidized direct loan – Available to undergraduates and graduates. Requires no proof of financial need. Your school determines the amount you can borrow based on the cost of attendance and other financial aid you receive. Interest accrues during all periods. 

PLUS Loans 

The government is the lender and guarantor on a PLUS loan, which goes to parents of dependent undergraduates or to graduate/professional students. The maximum loan amount is the cost of education minus any other financial aid. Borrowers may not have an adverse credit history. 

Direct Consolidation Loans 

These allow a borrower to consolidate multiple federal education loans into a single loan with one monthly payment. Consolidation can: 

  • Lower monthly payments. 
  • Provide a longer time to repay the loan. 
  • Expand access to additional loan repayment plans and forgiveness programs.  

On the downside… 

  • The extended time horizon means more interest will accrue and raise the total cost of the loan. 
  • The total interest rate may rise if the borrower consolidates lower and higher rate loans. 
  • The borrower may lose certain loan benefits. 

Before deciding on a direct consolidation loan, consider whether an income-based repayment plan, deferment, or forbearance are better options. Part 2 will discuss these and other student loan repayment strategies. 

Meanwhile, reach out to FJY Financial if you’re ready to make education part of your financial plan. We can help you plot a strategy that complements your other life goals.