With the cost of college education increasing every year, many students and their families turn to student or parent loans to bridge the gap when savings, grants and scholarships cannot pay all of the education bills. The CollegeBoard estimates that for the 2015-2016 school year, the average undergraduate tuition and fees at a public four-year in-state, on-campus institution will be $9,410, while tuition at a private, nonprofit institution will top $32,000. A decade ago, those tuition costs averaged nearly $5,500 and $21,000 respectively.
For most young Americans, a student loan is their first encounter with major debt, and when used responsibly, student loans can help build a positive credit history. Eligible student loans also provide some tax benefits to students after graduation because they can claim the interest paid on their student loan debt, with a maximum $2,500 tax write-off each year (subject to income phase-out limits, but most recent graduates would fall below this cap anyway).
Federal student loans offer greater protections and often lower fixed interest rates than private loans, so it's a good idea to exhaust your federal loan options before taking out private loans.
Federal Family Education Loan or Direct Stafford Loans
The United States Department of Education administers Stafford loans, which allow students to borrow money for college. Subsidized loans are available to students with demonstrated financial need.
With a subsidized Stafford loan, the government pays the student's interest while students are enrolled at least half time in a degree program. Because interest compounds over time, these modest federal subsidies can shave thousands of dollars from interest charges over the life of the loan. The government stops making interest payments to the lender six months after a student graduates or leaves school. At that time, students must begin making monthly payments of both interest (the cost of borrowing) and principal (the money borrowed).
For the 2015-2016 academic year, the interest rate on new Stafford loans for undergraduate students is fixed at 4.9 percent. Stafford loans for graduate and professional students are fixed at 5.84 percent. There is also a loan fee of just over one percent.
Students can save the most money on their education expenses by paying back the loan principal as quickly as possible. Borrowers in the military as of August 14, 2008 should contact their lender to find out if they are eligible to have their Stafford loan interest rate reduced.
Students who do not qualify for a subsidized Stafford loan or who max out their unsubsidized loan amount can still participate in the government's loan program by borrowing through an unsubsidized loan. As the name suggests, the unsubsidized loan does not carry the benefit of having the government pay the interest while a student is enrolled.
Whether or not a student qualifies for a subsidized loan, he or she must adhere to some government-imposed borrowing limits during their academic careers. Dependent students can borrow the following annual Stafford loan amounts:
- $5,500 in the first year (no more than $3,500 in subsidized loans)
- $6,500 in the second year (no more than $4,500 in subsidized loans)
- $7,500 in each subsequent year (no more than $5,500 in subsidized loans)
Dependent students can incur no more than $31,000 in total Stafford loan debt as an undergraduate and no more than $23,000 in subsidized loans.
Independent students and dependent undergraduate students whose parents are not able to obtain PLUS loans are eligible to borrow the following annual amounts in both subsidized and unsubsidized Stafford loans:
- $9,500 ($3,500 subsidized + up to $6,000 unsubsidized) in the first year
- $10,500 ($4,500 subsidized + up to $6,000 unsubsidized) in the second year
- $12,500 ($5,500 subsidized + up to $7,000 unsubsidized) in subsequent years
Undergraduate, independent students can borrow no more than $23,000 in subsidized Stafford loans with a total borrowing limit of $57,500, which includes unsubsidized loans.
Graduate students also take advantage of federal student loan programs because fewer scholarships and grants are generally available to help pay for advanced degree programs. Graduate students can borrow up to $20,500 each year, all of which is unsubsidized. The Stafford loan program for graduate students caps out at $138,500 (only $65,500 in subsidized loans), which also includes any loans disbursed during a student's undergraduate program.
Federal PLUS Loans
Parents of dependent students and graduate and professional students can borrow from the PLUS loan program. The interest rate for direct PLUS loans for the 2015-2016 academic year is 6.84 percent. Applicants must not have an adverse credit history. Applicants who have an adverse credit history may still be able to receive a loan by documenting extenuating circumstances or obtaining a co-signer.
Both parent and student PLUS loan borrowers can borrow up to the total cost of attendance minus any financial aid received. To apply for a PLUS loan, parents of dependent students are encouraged to file a Free Application for Federal Student Aid (FAFSA), and graduate and professional students are required to file one.
PLUS loan funds are first applied to the student's account to pay tuition and fees, room and board, and other expenses. For parent PLUS loans, any funds that remain are sent to the parent borrower; for student PLUS borrowers, any funds that remain are given to the student. All loan funds must be used for educational expenses. Unlike Stafford loan borrowers, PLUS borrowers must begin repayment of PLUS loans immediately.
For parent PLUS loans disbursed after July 1, 2008, the borrower can choose to defer repayment while the student is enrolled at least half time and for a 6-month period after the student is no longer enrolled (either because they graduate or leave school). The parent borrower must either make interest payments during these deferment periods or the accrued interest is capitalized (added to the principal). The repayment term ranges from 10 to 25 years depending on the loan term you choose.
Applying for Student Loans
All federal student loan programs use the FAFSA, which can be completed online or on paper. Some institutions also use data from the FAFSA to qualify students for student aid at the university level.
Remember, it does not cost anything to apply for student loans. Some unethical businesses attempt to charge a fee to "uncover" loan opportunities for unsuspecting families. The administrators of federal loan programs emphasize that this practice can be considered a felony in most states. Save your money and ask the financial aid counselor at your prospective college or university for assistance with any questions. They will be delighted to assist you.
Falling Behind on Student Loan Payments
Other creditors, like credit card companies or past landlords, will often hound you with phone calls, letters and harsh collection agencies if you miss your payments. Falling behind on your student loan payments can lead to even worse consequences. Failing to repay a student loan reduces your credit score more than just about any single act short of bankruptcy. A student loan in default can disqualify you from receiving federal aid and some of life's essentials like having a checking account or applying for auto insurance. It could also disqualify you from federal loan repayment programs.
Worst of all, defaulting on your student loan can exclude you from government hiring processes, as well as schools and law enforcement agencies. Many private employers also reject job applicants with a defaulted student loan on their records.
Fortunately, the Department of Education provides significant relief to student loan recipients who, through no fault of their own, cannot meet their regular monthly payments. By law, you can request up to twelve months of "forbearance" by simply contacting your lender and completing a simple form. During the forbearance period, you can skip your student loan payments while you work on getting a new job or putting your financial house in order.
Many student loan recipients who wind up in default say they were too scared or embarrassed to ask for help during hard financial times. In fact, the process is simple and painless. Lenders have no problem extending forbearance because they keep charging interest on your remaining balance during the forbearance period. If you default on your loan, government insurance programs reimburse them for a large portion of their loss.
Therefore, the government requires loan recipients to repay their obligations over time, no matter what. In most cases, student loans cannot be discharged in bankruptcy, nor can they be discharged like other forms of unsecured debt. Department of Education officials routinely garnish up to twenty-five percent from the wages of defaulted loan recipients. You can avoid these consequences by simply asking for help when you run into trouble.
You can also receive a deferment if you re-enroll in school at least half time, are unemployed and cannot find full-time employment, experience economic hardship, or work in the Peace Corps. Deferments are also available for active military duty. Contact your lender for details.
One of the key benefits of federal loans is the repayment options. The federal government offers several income-driven repayment programs not available to borrowers of private loans:
- Revised Pay As You Earn Repayment Plan (REPAYE Plan): As of October 27, 2015, the Department of Education issued a final regulation creating a new income-driven repayment program that improved on the Pay As You Earn Repayment Plan (PAYE Plan). The REPAYE Plan extends its protections to all student borrowers with direct loans, capping their monthly student loan payment amount at 10 percent of monthly discretionary income (the difference between your income and 150% of the poverty line based on your family size), regardless of when the borrower took out the loans. REPAYE will also forgive remaining student loan debt after 20 years for those who borrowed only for undergraduate study and 25 years for those who borrowed for graduate study.
- Income-Based Repayment Plan (IBR Plan): The IBR plan has been available to all federal borrowers with a partial financial hardship since 2009. It caps the monthly payment at 15 percent of your discretionary income (up to the fixed 10-year payment amount) and discharges the remaining balance after 25 years.
- Income-Contingent Repayment Plan (ICR Plan): The ICR plan has been available to all direct loan borrowers with no partial financial hardship requirement since 1994. It caps payments at the lesser of 20 percent of discretionary income or the 12-year repayment amount times income percentage factor. Like IBR, it discharges the remaining balance after 25 years.
Student Loan Forgiveness
Fortunately, you can actually earn full forgiveness (cancellation) of your student loan by participating in a number of state or federal loan forgiveness programs. For example, education majors can often have their loan slate wiped clean after teaching in underserved areas for five years.
Traditionally, military personnel can eliminate their student loan debt by participating in active military duty after graduation. Depending on your area of study, your college or university should be able to inform you about specific opportunities to wipe out your student loan debt while earning valuable career experience.
Finding More Information Online
- Federal Student Aid
This official United States government website explains who is eligible for federal loan programs, how they work and more.
Tuition and Fees and Room and Board over Time, The College Board, http://trends.collegeboard.org/college-pricing/figures-tables/tuition-and-fees-and-room-and-board-over-time-1
Student Loan Interest Deduction, IRS, https://www.irs.gov/publications/p970/ch04.html
Understand how interest is calculated and what fees are associated with your federal student loan, Federal Student Aid, https://studentaid.ed.gov/sa/types/loans/interest-rates
Programs for Military, Student Loan Borrower Assistance, http://www.studentloanborrowerassistance.org/repayment/programs-for-military/
The U.S. Department of Education offers low-interest loans to eligible students to help cover the cost of college or career school, Federal Student Aid, https://studentaid.ed.gov/sa/types/loans/subsidized-unsubsidized
Plus Loans, Federal Student Aid, https://studentaid.ed.gov/sa/types/loans/plus
Parents, Federal Student Aid, http://www.direct.ed.gov/parentrepay.html
Announcement of New REPAYE Plan, Federal Student Aid, https://studentaid.ed.gov/sa/about/announcements/repaye
Income-Based Repayment Plan (IBR Plan) and Income-Contingent Repayment Plan (ICR Plan), Federal Student Aid, https://studentaid.ed.gov/sa/repay-loans/understand/plans/income-driven