You might be used to thinking of your student loans as being a singular entity, but the fact is that there are many different kinds of student loans. You could have loans that are all the same type, or you could have a mix of different varieties. Because different kinds of loans come with different benefits, protections, and costs, it’s important that you understand the kinds of student loans available to you.
Broadly speaking, the two main types of student loans you will encounter are federal and private student loans. Each of these categories has sub-types that you should also be familiar with.
Federal Student Loans
Federal student loans are lent to you directly from the federal government, with interest rates set by Congress. These rates are typically cheaper than those you’d see on private student loans. To be eligible for a federal student loan, you must complete the FAFSA and await decision regarding your eligibility. You must remember to complete the FAFSA each year that you need aid, not just your final year of high school.
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Federal loans come in a number of forms based on the government program that they are managed under. Each has its own eligibility requirements and different potential benefits (such as student loan forgiveness, income-based repayment plans, etc.), so make sure you understand which loans you are signing on for when you accept your financial aid package. The four main types of federal student loans you will encounter are Perkins Loans, Direct Loans, Stafford Loans, and PLUS Loans.
Perkins loans are low-interest federal student loans available to both undergraduate and graduate students who have demonstrated exceptional financial need.
One of the things that makes the Perkins Loan program different is that your school is actually your lender, which means that you’ll ultimately be making payments to your college (and not the federal government or a lender). Unfortunately, all colleges do not participate in the program, so you should check with your university to make sure that they do.
Undergrads can borrow up to $5,500 in Perkins Loans each year, for a total of $27,500. Graduate students can borrow up to $8,000 in Perkins Loans each year, for a total of $60,000 (including any amount borrowed as an undergrad).
The grace period for Perkins Loans is 9 months after graduation or 9 months after you stop being a half-time student, at which point you’ll need to begin making payments. Perkins loans are not typically eligible for income-based repayment plans, but may be forgiven under certain situations.
Direct loans are available to undergraduate students who demonstrate financial need, and can be either subsidized or unsubsidized (more on this below).
The lender for Direct Loans is the Department of Education. These may also be called “Stafford Loans”
Students who are dependent on their parents or family members can borrow up to $31,000 in Direct student loans (and only $23,000 of this can be in the form of a subsidized loan). Independent undergraduates may borrow up to $57,500 in Direct Loans (again, with a limit of $23,000 on subsidized loans). Independent graduate students can hold up to $138,500 in Direct Loans (including undergraduate loans), with a limit of $65,500 for subsidized loans.
The grace period for Direct Loans is 6 months after graduation or 6 months after you stop being a half-time student, at which point you’ll need to begin making payments. Direct Loans are eligible for income-based repayment plans and may be forgiven under certain situations.
PLUS Loans are designed to bridge the gap if your other student loans do not fully cover the cost of your education. They typically come with higher interest rates than other kinds of federal student loans, though they are still usually much cheaper than private loans. These are technically managed under the same program as the Direct Loan program, but they are a distinct type of student loan.
PLUS loans can be granted to either:
- Graduate students who are enrolled at least half-time at a school participating in the PLUS loan program. These are called Direct PLUS Loans.
- Parents of dependent undergraduates enrolled at least half-time at a school participating in the PLUS loan program These are called Direct Parent PLUS Loans.
The lender for PLUS loans is the Department of Education. The maximum amount of PLUS loans that someone can have is the cost to attend their school, minus other financial aid received.
Credit history is taken into consideration when determining eligibility for PLUS loans, while it is not for other federal student loans. This means that if you are denied a PLUS loan, you will have to find a private loan to make up the difference in costs.
Unfortunately, PLUS loans are typically ineligible for income-based repayment plans, unless they are first consolidated into a Direct Consolidation Loan. Which brings us to our final type of Federal Student Loan…
Direct Consolidation Loan
Direct Consolidation Loans are unique in the world of federal student loans for one big reason: You don’t take out or accept a consolidation loan in the same way that you might accept a Direct Loan or a Perkins Loan. Instead, you actually create a Direct Consolidation Loan by combining multiple existing federal student loans into a single new loan.
People choose to consolidate their federal student loans for a number of reasons. Primarily this is to make paying back their loans less complicated, because managing one larger student loan is, obviously, easier than managing eight or ten smaller loans, each with their own payment, interest rates, etc. The other reason is that consolidating certain federal loans (like PLUS loans) opens up some new benefits that you may have been ineligible for under the terms of your original loan.
Though there is no fee to consolidate your federal student loans into a Direct Consolidation Loan, it is important to keep a few things in mind which may be reasons for you to not want to consolidate:
- Your interest rate does not change when you consolidate. Instead, all of your individual rates and loan amounts are merged together into what is called a new “weighted average” which ultimately means your loans are just as expensive as they were before you consolidated.
- You might wind up paying more in interest if you opt into a longer payback period. When consolidating your loan, you can change your repayment schedule to up to 30 years (vs. the traditional 10 years). Though this lowers your monthly payment, it means you’re paying more in interest over the life of your loan.
- Though you may gain some benefits (like access to income-based repayment plans not available to you under your current plan) you may lose other benefits like forgiveness options.
- If you are currently working towards income-driven repayment plan forgiveness (where you make a certain number of payments and then your debt is forgiven) consolidating your loans will reset the clock back to zero.
Also, keep in mind that only federal student loans can be consolidated. Private student loans cannot be consolidated with your federal loans.
If you’re thinking about consolidating your federal student loans, make sure you understand all of the pros and cons of consolidation before moving forward.
A Note About Subsidized vs. Unsubsidized Student Loans
Federal student loans generally come in two flavors: Subsidized and unsubsidized. But in the rush and excitement of receiving your student aid package, you probably haven’t given much thought to what the difference is between these two types of loans.
That’s a big mistake, because the difference between subsidized and unsubsidized loans can cost you thousands of extra dollars in interest as you pay off your student loans.
The differences between subsidized and unsubsidized student loans generally revolves around the way that interest accrues, with subsidized student loans being much more favorable for your wallet.
In short, subsidized loans don’t accrue interest while you are enrolled as a student or at any point that your loans are in deferment. Unsubsidized loans do accrue interest during these times, which means that unsubsidized loans will cost you a lot more money over the life of the loan.
This is especially true if, at the end of your college enrollment or period of deferment, you cannot pay the interest which has accrued. At that point, the interest is capitalized (or, added to the principal) which means that you will be paying interest on top of your interest. No bueno.
If you’ve got both subsidized and unsubsidized student loans, keeping everything in check and creating a repayment strategy might seem really overwhelming. Ultimately your payment strategy will depend on your own financial circumstances and long-term financial goals, but there are a few things that you should keep in mind.
To save as much money as possible it’s important to avoid interest capitalization, which is most likely to impact your unsubsidized loans (subsidized loans will only accrue interest during periods of regular repayment or during a period of forbearance). You can reduce the impacts of interest capitalization by working while you are enrolled in school and using that money to pay down your student loans while you are still a student to cover the interest that is accruing.
You can also do this by trying your best to not place unsubsidized loans into deferment. Instead of deferment, look towards income-based repayment plans as a way to make payments easier. If you do place your unsubsidized loan into deferment, the interest that accrues, especially if it capitalizes, can easily add thousands of dollars to your balance.
Private Student Loans
While federal student loans come directly from the federal government, private student loans come from a lender like a bank. Because these lenders are for-profit institutions (they want to make money) private student loans typically will carry a higher interest rate than a similar federal student loan. This means that private student loans have the potential to be much more expensive in the grand scheme of things.
Also, whereas federal student loans come with a number of benefits including access to deferment and forbearance options, income-based repayment plans, and potential student loan forgiveness, private student loans come with none of these options.
Private student loans can either be fixed-rate loans or variable rate loans.
Variable interest rates often start out lower than fixed rates, which makes them appealing to borrowers. But, because variable rates are tied to the prime rate set by the Fed, they can (and very likely will) change. The prime rate has been at historic lows for a number of years, but is expected to start rising soon, which means that a low variable interest rate now will very likely wind up being more expensive in a few years.
Fixed interest rates, on the other hand, do not fluctuate. For this reason, they are often a bit higher than variable rates. The added cost comes with a benefit, though: Even if the prime rate rises, your debt will never get more expensive so long as you have a fixed rate. It remains the same from the day you first accept the loan to the day you make your final payment (unless you choose to refinance).
I personally always recommend individuals choose fixed-rate loans over variable-rate loans, simply because I think it’s best to know up front what the cost of your loan is going to be, and variable rates don’t let you do this. But this is a decision that each borrower will have to make on their own.
Which are better, federal or private student loans?
Whenever possible, you should choose federal student loans over private student loans. Federal student loans have a number of benefits that you just won’t get with private student loans, including:
- Lower interest rates (usually)
- Ability to place loans into deferment or forbearance in times of hardship
- Possible student loan forgiveness if you meet certain eligibility requirements
- Income-based repayment plans
That being said, getting your financial aid package back can be an exciting and nerve-racking experience, and for good reason: It feels a lot like your entire future is contained in those forms. But it can also be overwhelming. How are you supposed to know which funds to accept and which ones to avoid? Which Loans are best? In what order should you accept your financial aid funds? When piecing together your payment options, this is the order that I would recommend you accept your financial aid:
- Scholarships and Grants, because they are free money. Remember, you may be eligible for both federal and state grants. Depending on the state you live in, you may need to apply for some state grants separately from your FAFSA application.
- Federal Subsidized Student Loans, because they will not accrue interest when you are in school or when your loans are in deferment
- Federal Unsubsidized Student Loans, starting with Perkins Loans if you qualify (since they come with the lowest interest rate) and ending with PLUS Loans (since they come with the highest interest rate)
- Private Student Loans, because they will have the highest interest rate and the fewest benefits.
Paying Back Your Student Loans
Paying back your student loans is likely to be the most difficult financial challenge that you’re going to face right out of college, because it’s hard to do. There are a lot of factors that go into successfully crushing your student loan debt, and everyone’s situation is different, but below is a quick set of steps you should take if you want to succeed:
- Keep track of your student loans
- Choose a student loan repayment strategy to follow
- Be consistent as you work towards your goal
For a much more detailed and nuanced explanation of how you can succeed in paying off your student debt, check out this student loan game plan that I wrote (and that I am personally following).