Types of student loans

Student Loans: What Should YOU Choose?

If you’re like the majority of students, student loans will accompany your time in college. In fact, 71% of all students who graduated in 2015 will leave college with student debt according to this Wall Street Journal article. If you’re a recent college graduate or a current student, this probably won’t surprise you too much, and chances are that you’re part of this group. What also may or may not surprise you is the average debt each person who falls into this group is facing.

$35,000. The horror!

For most graduates, this is likely pretty close to your entire first year’s salary. Obviously, you don’t need to pay it all back that first year, but having that debt over your head will definitely drag you down. Payments on this $35,000 will be roughly $350-400 per month if you have a 10-year, 6% student loan. If your starting salary is $50,000 per year, you’ll only end up taking home around $37,000 after taxes. Based on this math, you’ll be paying over 10% of your take home pay to just student loans.

And that’s with a $50,000 starting salary, which is about average, with an average amount of loans. How are you going to survive with your $30,000 per year starting salary and $70,000 in loans?

Good luck.

Now, as I mentioned in previous articles (Invest in Yourself First & Don’t Fret Over Student Debt), student loans may be a necessary investment. I’m not trying to turn your away from following your dreams, I’m trying to help you understand the best methods to making those dreams a reality. The first step is to figure out what financing will work best for your position.

Should You Take Loans?

If you’re still early in your high school career, you can set yourself up to get more free money through scholarships and to get into more prestigious universities. Honestly, I skated by, and now I’m paying for it. Don’t slack too much because it can end up costing you the same amount as buying a house. Also, way to go already reading about personal finance. You’re on the right track and off to a great start.

If you’re like the rest of us, it’s probably too late to have any control over the scholarships you’re offered. That’s okay though. There are still several options.

First, you could shop around at schools to see who offer the most bang for your buck. Is a 5% better education worth an extra $15,000 per year? Are you okay with spending twice as much on tuition because a school has a reputation for throwing good parties? Are there any benefits to living in the city/county/country?

Some colleges and universities in other states may actually have tuition for non-residents that are cheaper than what you may pay in your home state. Check out this article to see some inexpensive colleges. This page also lists the percentage of students who receive financial aid and the net price once financial aid is factored in. Plus, maybe you’ve always dreamed of moving to Florida, or the East Coast, or pretty much anywhere in the country, and these value-priced schools will give you the perfect opportunity.

If you aren’t interested in hunting for out of state schools, that’s totally okay, too. One great option for those who are early on in their college career is to attend a community college for the first year or two and then transfer to a 4 year program from a university. Your degree will be from the college you graduated from and you’ll have been able to knock out a lot of the general education requirements.

I know, I know, you’ve heard this option before, but you’re not interested because that’s boring. What you may not have heard is that the majority of major universities have a community college nearby. For example, Lansing Community College in Michigan is a 7 minute drive from Michigan State University. If you live in one of the qualifying school districts, you’ll pay $99 per credit hour, which will end up costing somewhere around $3,000 per year. Even if you budget $10,000 for living expenses, that leaves you at about $13,000 per year. MSU will cost you about $28,160 for a year according to their site. Basically, 2 years at Lansing Community College and then 2 years at MSU will cost you $30,000 less than 4 years at MSU.

I’d say that’s pretty good. If you’re absolutely opposed to these two options, you become a bit more limited.

First, you could work your a** off and try to earn enough money to pay off any tuition and costs you have. If you’re a student at any major university and have to pay $25,000+ per year for tuition and room and board, good luck working for that. You’ll need to make over $16 per hour before taxes if you’re working 40 hours per week. Not impossible, but you’re going to be exhausted and literally all of your money will be gone.

Your alternative, and the road most traveled, is to take out student loans. These can get tricky because of how many choices there are, so I’ll try to make it a bit simpler.

Types of Student Loans

You probably know that there are both government and private loans available. The tough part is knowing what your best option is. First, I’ll give a brief overview of some of the most common types of loans, starting with government offerings.

Direct Subsidized Loans: Government loans that are offered to people who show financial need. By financial need, they generally mean that you and your parents have a low enough income and difficult enough circumstances to qualify for this assistance. The major benefit of this type of loan is that the government will pay all interest on your loan while you’re still in school, meaning that the balance you borrow is the same amount you owe upon graduation. You are limited in the amount you can borrow, however.

Direct Unsubsidized Loans: Government loans that are offered to essentially anybody who needs them. This type of loan is essentially the same as most private loans in that the government does not offer any substantial benefits, however it is fairly common to see lower interest rates than those you might be offered from a private lender. Again, you are limited on the amount you can borrow.

As I mentioned, these government programs often have borrowing limits. To see a more detailed explanation of these limits, you can look about halfway down this government page to find a table with the information in it. At most schools, these programs will not offer enough to cover all expenses, and you will likely need to find additional funding elsewhere. Kind of annoying, if you ask me.

Next up, private loans:

Fixed Rate Loans: “Fixed rate” means that the interest rate on your loan will never change. Whatever the rate you’re offered at the beginning is, is what it will be for the term of your loan. This makes the loans much more stable and predictable, however they’re also potentially more costly short-term.

Adjustable Rate Loans: “Adjustable rate” means that the interest rate you’re being charged on the loan may, or may not, change over the term of the loan. If you’re able to get a low initial rate and you plan to pay it off as soon as humanly possible, this may be a good choice. It is a bit riskier though, as the rate may increase dramatically, depending on how the US market is behaving. So your 4% adjustable rate could shoot up to 8% over the next 3 years. Or, it could stay at 4% and save you some money over the 6% fixed rate option. Your choice.

Private loans will generally be a little bit (or a lotta bit in some cases) more costly than government loans, but they will also be quite a bit more convenient. Most lenders will allow you to borrow more than enough to cover all of your tuition and offer a bit more flexibility in products. Some private loans will allow you to have a different repayment period, while government loans commonly have 10 year terms.

Regardless of your loan type, you’ll likely end up paying a pretty penny in the end.

Strategies to Reducing Payments

Aside from cutting your education costs in the first place, there are also some strategies that might help to make your education more affordable. Obviously you don’t want to spend money on a loan. But, it’s probably inevitable. So, try to cut your costs through some of the following tricks.

First, if you’re still in school and need to take loans, you can combine government and private loans. It can be a little bit of a pain, but if you can get the maximum amount through the federal program at a 5% interest rate, and then take a private loan to cover the rest at (likely) a little bit higher rate. This likely won’t save you a TON of money, but $5 a month for 10 years is still $600. After 4 years of combining, you could end up saving several thousand dollars over the life of the loans. Worth it.

Another technique that may be beneficial upon graduation is loan consolidation. This means that you can take any loans that the consolidating company (i.e. the bank) considers eligible and combine them into a single loan. If you have good credit and interest rates in the market are low, you’ll likely be able to cut a little bit off your interest rates. This will probably, again, save a fraction of your monthly expenses, but $20 per month adds up after 10 years. Again, worth it.

I’m sure you’ve also heard people say “pay down your debt/student loans as fast as possible.” Well, in my opinion, yes and no. If you have several high interest rate loans and several low interest rate loans, it’s probably smart to pay off the high interest ones ASAP. This is up to you, but I would consider anything below 4% to be low interest and anything above that to be high interest. Yes, this debt is bad, but it makes more sense to invest the money in a fund that earns 7% yearly than to pay down a loan that charges 3.5% yearly. On the other hand, anything that falls into that “high interest” category is costing you more money and may prevent you from buying a home, a car, or other things in the future. Plus, if you lose your job, you’ll still have that student loan expense each month. And, unfortunately, it doesn’t go away if you go bankrupt.

This article has gotten extremely wordy, and I’m sorry to make you suffer through it. However, student loans are something that you, or someone you know, will also suffer through. According to this article, student debt amounts to $1.2 trillion in the US alone, which is second only to mortgage debt. It’s huge.

If you’re a student, or you have student debt, take actions to minimize it. Choosing to wait until it’s too late will really drag you down in the future. Understand what options you have so you don’t go from being a broke college student to a broke college graduate.

Choosing to have a limited knowledge about your loans means you’re choosing to spend extra money for the next decade. Your family would probably appreciate that extra few hundred bucks each month.

Learn now and make the right decision, or you could end up having to hand wash diapers.  Gross.

 

Do you have student debt? What actions have you taken to reduce the amount you owe? Leave a comment and share your experiences!

7 comments

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  2. When paying back your loans, is it smarter to pay only the minimum monthly amount or to pay bigger chunks when you can? I’ve heard it messes with your credit score.

    1. Hey Jodi, thanks for the question, and sorry for the slow response! It’s true that varying the amount you pay can affect your credit score, but it can get a little tricky. Credit scores are calculated somewhat counter-intuitively. So, logically, we would think that living with no debt and not having to make any payments would be smarter because we aren’t paying interest on things. Technically, it is, but your credit score won’t reflect this in a positive way.

      Your credit score is built off of your credit history. This means that it is calculated based on how consistently you’ve made payments (i.e. not missing payments), your credit utilization (what % of your available credit are you using – most would say to try to hover around 30%. AKA, your credit card line can go up to $10,000, but you only have $3,000 of it used), and a combination of several other credit factors. For a more detailed breakdown, this article should help.

      Long story short, it will actually help you more to keep making minimum payments because it will build up more of a credit history. It will help your score if you pay down loans early (and save you money), but as far as your credit score is concerned, the longer your history and the more payments you make, the better.

      Hope this helps!

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