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Going to college can be the next step that helps open all the doors for you in your career, but there’s no hiding the cost. Whether you’re thinking of going to community college or heading to your dream school out-of-state, you’ll need to think about securing student loans to pay for your tuition and other fees.
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It’s a smart move to compare student loans and go into them with your eyes open so you don’t end up struggling to pay them when you graduate. Many students take the loans without thinking about them, and regret it later. Student loans can help you access the education you need to land your dream career, so by understanding what they are and how they work, you can borrow with confidence.
What is a student loan?
A student loan is a type of loan specifically designed to help students pay for their education-related expenses, such as tuition fees, books, housing, and other educational costs. These loans are offered by various financial institutions, including banks, private lenders, and the government.
When a student takes out a loan, they agree to borrow a certain amount of money and are obligated to repay it, usually with interest, over a specified period of time. The terms and conditions of student loans can vary depending on the lender, the type of loan, and the borrower's creditworthiness.
How do student loans work?
Student loans provide financial assistance to students for educational expenses. You apply for a loan, get approved based on factors like credit and income, and receive funds for tuition and other costs. Interest may accrue during school. Repayment starts after graduation, and you have various options and repayment plans. Loan servicers manage the loans. Understanding terms and making regular payments are essential.
What are the different types of student loans?
There are two different types of student loans:
- Federal student loans
- Private student loans
Federal student loans
Federal student loans are provided by the US government. This is the type of loan you should look to acquire before looking for private student loans.
Federal student loans are less expensive than private loans due to lower, fixed interest rates and you are likely to find them more convenient as they have varying payment plans.
These type of loans allow you to borrow the money you need to pay for college without needing a co-signer and you may even have your loan forgiven, i.e. no repayments need to be made, if you go on to work in an eligible profession such as public service or teaching.
There are four types of federal loans on offer depending on your level of education and financial circumstances.
- Direct Subsidized Loan: this type is available to undergraduates with confirmed financial needs. Since this type of loan is subsidized, you will not have to pay interest while at college and for a further six months after graduating.
- Direct Unsubsidized Loan: this type is available to undergraduate and graduate students, irrespective of financial situation. You will be required to pay interest while enrolled in college or it will be added to your loan amount.
- Direct Grad PLUS and Direct Parent PLUS Loans: this type is available to graduates and the parents of dependent undergraduates. Interest will build as soon as the full loan amount is released. However, repayments can be postponed while in college and for a further six months after graduating.
- Direct Consolidation Loan: this type enables you to combine federal student loans while maintaining all the benefits. This is a good option if you need to restructure your repayments.
Private student loans
Private student loans are those borrowed from a private lender, this typically being a bank, state loan agency, credit union, or other financial institution.
As private loans are offered by many different lenders they will all come with different interest rates (both fixed and variable), varying loan amounts, and the majority will require a co-signer if you have no credit history.
Unlike many of the federal loans, a private loan will begin building interest as soon as the money is borrowed.
When you are looking to pay for college it is always a good idea to look into the possibility of a scholarship or grant (i.e. financing that you will not have to pay back) before looking to borrow money. If this is unavailable to you, always start with a federal student loan, considering a private loan as a last resort.
Pros & cons of student loans
As with any type of loan, student loans also come with pros and cons.
- student loans allow you to go to college when you otherwise wouldn’t be able to afford to
- you can be rewarded for having excellent credit, e.g. with a lower interest rate
- you can often borrow more than with a federal student loan – this is particularly beneficial if your dream school is more expensive than your federal loan will cover
- a private student loan can be used for whatever you want or need it to
- paying off your student loan on time will help you build your credit score
- private student loans can be expensive due to higher interest rates
- private student loans will not come with an income-driven repayment plan or any federal forgiveness
- you may be subject to variable interest rates on your private student loan meaning that your monthly payments can fluctuate
- private student loans come with no federal subsidy – this means that interest with kick in from day one and you may have to pay interest while you are still enrolled in college
- you are likely to need a co-signer if you take out a private student loan
- you will start your career in debt
- ensuring you can make your repayments may mean putting off big life steps
- your credit score will take a dive if you default on repayments
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What is the average interest on a student loan?
How much interest you will have to pay on a student loan depends on whether your loan is subsidized or not, the loan balance, loan term, and, of course, the interest rate.
The interest rate of a federal student loan is set by Congress, and fixed each year, however, the interest rate on a private student loan will vary lender by lender.
According to the Education Data Initiative, the average interest on a student loan, both federal and private, is currently 5.8%, with federal student loans at an average of 4.12% and private student loans at an average of 6-7%.
What is the average monthly payment for student loans?
According to the Federal Reserve Bank of New York, the average monthly payment for student loans is $393.
Can student loans be paid off early?
Yes, student loans can be paid off early. If you are in a financial position to do so, paying off your student loans early will be very beneficial, preventing a further build-up of interest. Just be sure to check with your lending agreement about any possible charges, although penalties are usually not incurred.
Will I need a co-signer for a student loan?
If you are taking out a federal student loan you will not need a co-signer. However, if you are taking advantage of a private student loan, you will more than likely need a co-signer, unless you already have good credit and a steady income.
Don’t forget that your co-signer needs to be someone with whom you have a mutual trust as they will become responsible for your repayments should you be unable to make them, and their credit score can be affected if you are late with your payments.
What credit score do I need to apply for a student loan?
If you are applying for a federal student loan you will not need a credit score, but if you need to apply for a private student loan you, or your co-signer, will need a credit score of 670+, otherwise you will be unlikely to qualify for a reasonable interest rate.
You may find a handful of lenders that will look at earning potential if you do not have a credit history, but they will also only offer loans with particularly high interest rates.
Can a student loan be refinanced?
Any student loan can be refinanced with a private lender so that you can take on a loan with more desirable terms. You should be aware, however, that if you refinance a federal student loan, you will not be able to get back on that program and so you may be giving up the benefits, such as income-driven repayments or subsidies.
How to choose the best student loan
When you need to fill a financial gap that cannot be covered by a federal student loan, a private student loan may be just what you need.
To choose the best student loan you need to compare loan offers from all possible lenders, including loan amounts, repayment terms, interest rates, and possible fees.
It is a good idea to only borrow an amount that will keep repayments to about 10% of your calculated monthly income when you finish college. This way you can avoid taking on more than you can chew and getting further into debt.
How do I apply for a student loan?
To apply for a student loan, follow these general steps:
- Research Loan Options: Explore different types of student loans, such as federal loans and private loans. Understand the terms, interest rates, repayment options, and eligibility criteria for each loan.
- Complete the FAFSA (if applicable): If you're in the United States and interested in federal student loans, complete the Free Application for Federal Student Aid (FAFSA) online. This form determines your eligibility for federal aid programs, grants, and loans.
- Gather Documentation: Collect necessary documents like identification, income statements, and academic information. Private lenders may have additional requirements.
- Choose a Lender: Select a lender that offers the loan terms that best suit your needs. Compare interest rates, repayment options, and borrower benefits.
- Fill out the Application: Complete the loan application provided by the lender. Provide accurate personal, financial, and educational information as requested.
- Co-signer (if needed): If you have limited credit history or income, you may need a co-signer, such as a parent or guardian, who agrees to be responsible for the loan if you can't make payments.
- Loan Approval: The lender will review your application and determine if you qualify for the loan. They will communicate the loan amount, interest rate, and terms if approved.
- Accept the Loan: Review the loan offer carefully. If you agree with the terms, accept the loan by following the lender's instructions. Be aware of any deadlines for acceptance.
- Entrance Counseling (for federal loans): If you're taking out federal student loans for the first time, you may need to complete entrance counseling to understand your rights and responsibilities as a borrower.
- Disbursement: Once your loan is approved, the funds are typically sent directly to your educational institution. The school applies the loan to your tuition fees and related expenses, and any remaining amount may be provided to you for other educational costs.
Loan rate & terms disclosure: Prequalified rates are based on the information you provide and a soft credit inquiry. Receiving prequalified rates does not guarantee that the Lender will extend you an offer of credit. You are not yet approved for a loan or a specific rate. All credit decisions, including loan approval, if any, are determined by Lenders, in their sole discretion. Rates and terms are subject to change without notice. Rates from Lenders may differ from prequalified rates due to factors which may include, but are not limited to: (i) changes in your personal credit circumstances; (ii) additional information in your hard credit pull and/or additional information you provide (or are unable to provide) to the Lender during the underwriting process; and/or (iii) changes in APRs (e.g., an increase in the rate index between the time of prequalification and the time of application or loan closing. (Or, if the loan option is a variable rate loan, then the interest rate index used to set the APR is subject to increases or decreases at any time). Lenders reserve the right to change or withdraw the prequalified rates at any time.
Requesting prequalified rates on Credible is free and doesn't affect your credit score. However, applying for or closing a loan will involve a hard credit pull that impacts your credit score and closing a loan will result in costs to you.