Consumer Blog

If you’re planning on going to college, you’ve probably been doing some thinking about how you’re going to pay for it. And, you’ve likely been wondering, “Should I take out a student loan?” Before you answer that question, you need to know the basics. Here’s a rundown.

What Is A Student Loan?

A student loan is a sum of money borrowed from the federal government, state government, or a private company. The funds can be used to help pay for tuition and other related expenses (room and board, textbooks, etc.). Student loans can also be used for qualifying trade and vocational schools.

Experts say you should start thinking about college during your first year of high school. While you don’t immediately need to ask yourself the question, “Should I take out a student loan?” you should consider what you want your future career to be. Once you know the field you want to go into, you’ll be better positioned to decide on a school and get estimates on your starting salary. The best rule of thumb for taking student loans is to never borrow more than you expect to earn in your first year’s salary out of school. For example, if you’re going into education, you may not earn more than $40,000 right out of college, but if you pursue engineering, you may earn closer to $100,000.

Ideally, you’ll put yourself in a position to borrow as little as possible. “Make sure you go to your high school counselor and do shadow days and internships…all the things that will make you a good candidate for the scholarships and the schools you want,” says Reyna Gobel, author of Graduation Debt: How to Manage Student Loans and Live Your Life. “Then, you’ll be in a better position to evaluate whether a school is worth the money.”

The Different Types Of Student Loans

There are three different sources of student loans, with some key differences:

Federal Student Loans: Within the U.S. Department of Education’s federal student loan program, there are four different types of student loans available, including:

• Direct Subsidized Loans: These are loans for undergraduate students who demonstrate a certain level of financial need. They can be used to help cover costs at a college or career school. The maximum amount you can borrow ranges from $5,500 to $12,500 annually, and depends on what year you are in school, as well as whether or not your parents claim you as a dependent (also known as your “dependency status”).
• Direct Unsubsidized Loans: These loans are available to undergraduates, graduate, and professional students. Financial need is not a factor. Similar to Direct Subsidized Loans, for undergraduate students, the amount you can borrow ranges from $5,500 to $12,500 and depends on what year you are in school, as well as your dependency status. Graduate or professional students can borrow up to $20,500 annually.
• Direct PLUS Loans: These loans are available to graduate or professional students, as well as to the parents of dependent undergraduate students. When taken out by a parent, they’re commonly known as “Parent PLUS Loans.” When a graduate or professional student borrows, they’re known as “Grad PLUS Loans.” The maximum amount you can receive via a PLUS loan is the cost of attendance at the school you are enrolled in, minus any other financial aid you’ve received. A credit check is required.
• Direct Consolidation Loans: It’s important to note you can have more than one type of federal student loan. A Direct Consolidation Loan provides a way to bring all those eligible loans together into a single loan with a single loan servicer.

State Student Loans: State student loans are provided and guaranteed by government agencies in your respective state. Each state program has its different criteria and features. For details on what’s available in various states, visit the U.S. Department of Education’s list of state contacts.

Private Loans: Last but not least, there are private student loans. Private student loans are offered by private lenders (banks, credit unions, or online lenders). The maximum amount you can borrow is determined by your college’s tuition, less any financial aid you might be receiving. Additionally, most private lenders have aggregate loan limits ranging from $75,000 to $120,000 for undergraduate students, with a higher ceiling for graduate and professional students.

Should I Take Out A Student Loan?

As you plan to pay for college, you’ll want to factor in scholarships and any assistance you may be getting from your parents (if any). If that total is short of what you need for tuition and related expenses, then it’s time to start shopping for student loans.

The best place to start is with Federal Direct Subsidized Loans, which are the “gold standard” among the borrowing options, thanks to a number of perks. With these loans, Uncle Sam pays the loan interest while you’re in school, during the grace period and when the loan is in authorized deferment. On top of that, subsidized federal loans have a low fixed interest rate for the entire life of the loan that doesn’t depend on you having a pristine credit record (or, in fact, a credit history at all). They also offer certain benefits, such as income-based repayment plans, that are unique to federal student loans.

If you’re ineligible for a Direct Subsidized Loan or want to augment the amount you borrow, federal Direct Unsubsidized Loans offer the same low, fixed interest rate, and flexible repayment options. Unlike Subsidized Loans, Direct Unsubsidized Loans begin incurring interest as soon as the funds are disbursed to your school. (And, if needed you can have a combination of direct subsidized loans and unsubsidized loans.)

Many students will find that even if they are approved to borrow the annual maximum amount in federal loans, it won’t be enough to cover all their costs. Once you’ve exhausted your federal loan options, grant possibilities and scholarships, it’s time to jump into the world of private student loans. Smart comparison shopping will help you avoid getting in over your head as you try to fund your education.

Again, private lenders allow you to borrow up to your full cost of attendance. Also note that unlike federal loans, many private loans may require the student to enlist a cosigner (most often a parent or guardian) who is also on the hook for the debt. As you shop around, you’ll want to keep the following factors in mind:

• Interest rates: The interest rate on your loan is essentially the fee (expressed as a percentage) that you pay to borrow the funds. When you make your payments each month, a portion will go toward repaying what you borrowed (also called the loan principal) and the rest will go to pay interest charges. Rates will vary by current interest rates as well as by lender and depend on your credit history or your cosigner’s credit history. You can increase your chances of qualifying for a low rate by making sure your credit, or your cosigner’s, is in tip-top shape before you start applying. Another comparison shopping point is whether you want a fixed or variable interest rate. A fixed rate gives you security in knowing exactly how much you’ll pay over time. A variable rate will likely be lower at first (and maybe always). But it will move over time based on the broader interest rate environment.
• Loan term: The loan term is the amount of time it will take to pay off your loan. Ten years is the standard repayment term for federal loans, but private lenders offer  repayment options up to 20 years. Although your monthly payments may be lower with a longer term loan, you’ll generally pay much more in interest by giving yourself a longer runway to pay it back.
• Loan fees: Some lenders charge one-time setup fees (called “origination fees”) based on the amount you borrow. It’s important to know how much those are and factor them into the total price you’re paying for the loan. From the borrower’s perspective, the best student loan is the one with the lowest cost. That’s based on the initial loan amount, interest rate, the loan term (how long you have to pay it back), and loan fees. Making sure you shop around for the best rates and flexible repayment plans is incredibly important!

How Much Should You Borrow?

After you’ve answered the question, “Should I take out a student loan?” the next topic to tackle is exactly how much you should be borrowing. For over 43 million Americans, student loans were essential to their obtaining an education and earning a living. “Studies show most people who get college degrees see their earnings potential go up,” says Betsy Mayotte, President of The Institute of Student Loan Advisors. “That’s worth it if it’s more than the debt you took on.”

That said, there’s no denying many people borrow more than they probably should…and the ramifications of overborrowing can drag on for decades.

The Keys To Keeping Borrowing Costs Down

It goes without saying that the less you borrow, the easier it will be to pay your student loans back. Luckily, there are a number of ways to keep your borrowing costs down.

For many, it starts with a little negotiating. “When it comes to paying for college, negotiation is part of it,” says Gobel. “This is especially true if you’re choosing between schools and one is offering you more scholarship assistance. You can say, ‘look, I’m choosing between these two options. This one will leave me with less debt, but your school is the one I want to go to.’ Always make them feel good about their school,” she suggests.

Also, don’t delay when it comes to filling out your Free Application for Federal Student Aid, commonly known as the FAFSA. The FAFSA form determines how much financial aid you’re eligible to receive from colleges.  This includes grants, scholarships, work-study funds and loans. “Fill out the FAFSA [as soon as you can], because some grants are first come, first served,” urges Gobel.

Gobel also suggests looking into your eligibility for the American Opportunity Tax Credit. For qualifying students, the tax credit is for certain education expenses incurred during the first four years of college. The maximum annual credit is $2,500 per eligible student. The student, someone claiming the student as a dependent or the spouse making college tuition payments for their partner can claim the American Opportunity Tax Credit.

You’ll also want to consider community colleges to help lessen the burden. This includes taking community college courses while you’re in high school. Oftentimes, high schools will offer them for a fee. It’s a great way to get your basic course requirements completed before you even set foot on a college campus. According to Gobel, doing so can save you one to two semesters of coursework (and the college tuition that goes along with them!).

Student Loans Can Pay Off, But Be Smart About Them

Yes, debt can negatively impact your future, but there are benefits to taking out student loans. Namely, helping you to obtain the education you need for your future career. Getting a good education (at the best possible price) is essential to a stress-free future.

from our partnership with HerMoney/Filene