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3 Tips for Smart Student Loan Borrowing

Dec 05, 2019

When it comes to paying for college, the process can seem overwhelming. There are so many financing options out there and you might be feeling lost about how to choose the correct ones for your family. The key is to equip yourself with information so that you can have the knowledge you need to make an informed decision, especially if taking out a student loan.

To ensure students are taking full advantage of their financing options for college, free money, such as scholarships and grants, should be applied first. Once applied, the total cost remaining can be paid for using savings, income throughout the semester or student loans. Student loans are the most common way to pay for college. There are two primary sources of student loan funding: federal Direct loans and private student loans. The two programs differ in fundamental ways: the money for federal Direct loans comes from the Department of Education whereas private loans come from places like credit unions and banks. Federal loans are need-based and much more standardized, providing the same rates and fees to all borrowers. Students should take advantage of federal Direct loans before moving on to private loans if they still need extra money to cover education costs.

For some families, private loans are a good option because they offer competitive rates and a cosigner option to help student-borrowers gain approval. Other families will choose federal Direct PLUS loans (Parent Loan for Undergraduate Students), which can be easier to get and offer flexible repayment options, like income-based repayment, but tend to have higher fees and interest rates. The parent also remains the borrower for the life of the loan, with no ability to transfer it to the student after graduation. Whichever type of loan you choose (and some families take out both private and federal loans), there are a few ways to borrow smart.

Don’t borrow more than you need. Many families get caught up in the availability of what may seem like free money and end up taking out a bigger loan than they need, just because the option is there. But a loan is not free money, even though it is labeled as “financial aid” on a student’s award letter. Every cent you borrow has to be paid back in the future, and often with interest, which can sometimes be up thousands of dollars on top of the loan principal. Don’t take out too much money from a student loan; it should be used for education costs only. Take a careful look at actual expenses and remember that interest will accrue on the total balance. You can use a Student Loan Payment Amount Estimator to get an idea of what your payments might look like once you’ve graduated. Be smart about the debt you’re taking on and consider other ways you may be able to help cover costs associated with college.

Review federal loans first. Federal student loans tend to have the most favorable terms and flexible repayment options, and you generally don’t need a cosigner. To receive federal loans, families must submit the FAFSA form, which is available every October 1 for the next academic year. Even if you don’t think your family will qualify for need-based aid, you should submit the FAFSA anyway. Every student that files one, regardless of family income level, is eligible for some type of federal student loan. You never know what you might be eligible for or how your family’s needs will change before the fall. There are different types of Federal Direct Student Loans, including Direct Subsidized Loans, Direct Unsubsidized Loans, and as noted above, Federal Direct PLUS. Some can be covered by debt forgiveness programs, like the Public Service Loan Forgiveness Program, but when you’re taking out a loan it’s best practice to assume that you will be paying back the entirety of the balance.

If you need more money, look into private loans. Federal Direct student loans have limits to the amount that can be borrowed each year, so if facing a tuition shortfall, you may need to review private education loan options. Private loans come from credit unions and banks and most often require a co-signer since the loans go through a full underwriting process. All private loans differ, their interest rates may be fixed or variable and some require a minimum payment while still enrolled in school. In addition, some private lenders offer cosigner-release which removes the cosigner from the loan obligation once the student establishes good repayment habits, something Direct PLUS loans do not do since they are in the parent’s name.

Though a private student loan may be daunting, it’s one of the best options when looking to fill a shortfall after aid and federal loans. Making educational expenses on a credit card or through another line of credit offering may be more expensive over time.

When taking out loans, make sure you can answer the following:

  • How long will interest be charged?
  • What is the grace period on the loan, that is, how much time will pass between graduation and when the first payment is due?
  • Who will be the cosigner on the loan, if you need one?
  • Is a payment required while in school?

There are many factors to consider and like most aspects of the college process, the answers will differ among families. With some research, you’ll feel more equipped to make the right choices for you. Good student loan borrowing is about understanding the options and choosing the option that fits your needs best.