It's an exciting time of year for high school seniors, who, in addition to getting everything secured to graduate, are also cementing plans about what they're going to do come fall. Continuing on to college is a likely option and one that has been wildly growing in popularity over the past few years. Watching young family members head off to tour college campuses brings me back to more than a dozen years ago when I was in similar shoes. I was so enamored with the idea of my college experience that I wasn’t thinking about any of the financial details. Frankly, it didn’t seem like something I had to worry about at the time, so why kill my educational buzz? Additionally, I was confused and overwhelmed by the paperwork as was my mother, who was struggling with her own finances at the time.
Though the student debt crisis has considerably worsened since then (now topping 1.48 trillion and likely to increase as universities get even pricier), it looks like misconceptions still abound. A new survey by Student Loan Hero (SLH) found that 52 percent of borrowers think interest doesn’t accrue while they’re in school, 53 percent think student loan payments are automatically based on their income and roughly 70 percent are misinformed about student loan forgiveness. It all begs these questions: How do student loans work and how can parents and students make the best choices when venturing down that prickly path?
First, Reach Out To Your School Counselors and Use A Student Loan Calculator
“I would recommend that high school students and their families speak to their school counselors for guidance on the financial aid and student loan borrowing process,” says Rebecca Safier, financial expert at SLH. “Your college financial aid process can also offer help and information.”
“Our dashboard and calculators are also really useful tools for tracking your balances and monthly payments and coming up with a strategy for repayment,” she adds. Note: repayment is designed to span 10 years, or 120 payments, and includes interest.
Fill Out Those Federal Grant Forms — You May Get Some Free Money
The first thing any prospective college student needs to do is to find out if they qualify for any federal grants by filling out a FAFSA form. You’ll also need to fill this out to qualify for a federal loan (which we break down below).
As Brianna McGurran, student loan expert at NerdWallet explains, federal grants are based on financial need, so if you and/or your family is in a low income bracket, where you can provide little or no payments for college, you can qualify for a Federal Pell Grant, “which is worth about $6,000 a year,” says McGurran.
Aim For A Loan That Will Only Take 10 Percent Of Your Income
Ever hear of the 30 percent rule, the recommendation that your housing expenses do not exceed 30 percent of your annual income? Well, there’s a rule for student loans too, if you can swing it.
“We recommend that students pay no more than 10 percent of their income towards their loans when they graduate,” says McGurran. If you don’t know what sort of career you’re entering into, check out the National Associations of Colleges and Employers (NACE) report that ranks average starting salaries according to industry.
Go For A Federal Loan, And Add In A Private Loan As A Last Resort
If you’re taking out a student loan, experts strongly recommend going federal, and only taking on private if you’re looking to enhance the federal loan, which is controlled by the government (via the U.S Department of Education).
“But there is a limit on how much you can take out with federal loans,” says McGurran. “For instance a first year undergraduate who is a dependent student, meaning receiving financial support from a parent, can only take out $5500 a year. If you are an undergraduate and have no financial help, you can take out $57,500 over the course of your whole college career.”
Private loans are offered by banks, credit unions and other private companies.
“Private loans should be your last resort after you have exhausted after every other funding option including scholarships,” says McGurran. “They can then fill a gap, but they generally come with higher interest rates and less flexible payment terms. Federal loans can offer you loans based on your income, and you can actually pay less when you graduate if you have federal loans whereas with private you're pretty much stuck with the payments and it's very hard to get modifications.”
Know The Difference Between A Subsidized And An Unsubsidized Federal Loan
“A lot of people don't know the difference between direct subsidized and direct unsubsidized loans,” says Tim Lavelle, who runs the site ForgetStudentLoanDebt. “With a subsidized loan, the U.S. Department of Education covers the interest for you while you’re in school so it is not accumulating. It’s harder to qualify for these loans because of the income requirements.”
An unsubsidized loan can be obtained by anyone, regardless of their income levels, and how much you borrow is determined by your school based on all other financial aid factors, and you get no cuts with interest, and it will continue to build even while you’re in school.
Both types of loans typically offer a six-month grace period to begin paying them back.
What Forbearance and Deferment Entail
If you can’t afford to make your federal student loan payments, you can apply for a deferment or forbearance. They both enable you to postpone or reduce payments but they’re not the same thing.
“Deferment you can get if you’re unemployed, and it can be good for up to three years,” says McGurran. “Forbearance is a bit squishier. You can get it if you experience a financial hardship such as medical issue, but really it depends on the circumstances. The key with forbearance is that if you have an unsubsidized loan, your interest will continue to accrue.”
This last point is a stickler, as Makenzi Wood, a 2013 liberal arts college graduate who blogs about student loan journey for Picky Pinchers found out the hard way.
“[My husband and I] did forbearance because we couldn't afford the monthly payments right out of school,” Wood says. “Forbearance sounds like a great feature when you're strapped for cash, but I didn't realize interest continued accruing during forbearance. It increased my debt load and made it more challenging to pay off the debt.”
It’s Tricky To Qualify For Loan Forgiveness (And You May Still Have To Pay The Taxes On It)
Public Service Loan Forgiveness enables graduates to have outstanding loan debt erased completely. But there are two big caveats: you need to have worked in public service, the non-profit sector or the government for 10 years (or made 120 student loan payments), McGurran says, adding that only federal loans are forgiven — not private loans. This program is poised to be eliminated under the Trump administration.
“It is on the chopping block based on the [House Republican’s HEA Bill], but borrowers don't need to be worried just yet,” says McGurran. “It could be eliminated but if so, it would likely become effective for future borrowers, and most likely those working toward forgiveness would be grandfathered in.” If you do qualify and have outstanding debts forgiven, you do not have to pay taxes on the unpaid sum.
You do have to pay taxes on another type of forgiveness program: income-driven repayment plans. “With these, offered by the federal government, you can pay 10 or 15 percent of your income towards your loans which makes it much more affordable,” says McGurran. “The catch is your repayment timeline is extended quite a bit so you're repaying over 20 or 25 years, and though at the end your balance is forgiven, you have to pay the taxes on it.”
Parents, Be Careful When You Take Out Loans
Parents may want to take out their own loans to help their kids through school, which is of course, their call, but experts strongly urge that they be wary in biting off more than they can chew.
“Parents have a lot of room to borrow which is where they can get into trouble,” McGurran says. “Use a retirement calculator to help you figure out how much you need and what you should save each month to get there. And don’t put your savings in jeopardy. Remember, students can borrow for school; parents can't borrow for their retirement.”
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