Saturday, February 4, 2017

Student Loans: Applying for Federal vs. Private Loans

Knowledge is power.  That's a motto I live by, and it's what got me into student loan debt in the first place.  I absolutely love to learn.  Unfortunately, there are a few things I could have stood to learn earlier in life.  One of those things has to do with student loans.  Not all student loans are created equally.  Since the season for financial aid applications are upon us, let's look at the options.

The first thing to know is that there are two different kinds of student loan debt.  There are private student loans, and federal student loans.   When enrolling in a college or university, you generally submit a FAFSA form, which is the application for federal financial aid.  After submitting, and waiting for a while, a notice comes in the mail with information about how much money has been "awarded."  If the letter uses the word "grant" then you know you just won the jack-pot because you don't have to pay back a "grant."  If you see the word "loan" anywhere in the "award" letter, you will have to pay them back.  The loans will say "subsidized" or "subsidized."   The primary difference between them is whether or not the government is going to pick up the tab for the interest accruing while you are in school.  If you have a "subsidized" loan, this means that you have demonstrated "financial need," and the government will pay the interest during certain points in time.  If it is "unsubsidized," there is no "financial need" requirement, and you are responsible for the interest during all times.  Additionally, each year, the federal government puts a cap on the amount they will let students borrow (between $5500-$12,500 for undergraduates in 2016).  If you need more than that, you have to make up the difference.  This is where private loans come in...

If you (or your child) wants to go to a school that is more expensive than the federal government loan cap can fund, you need to make some tough choices.  You need to either choose a less expensive school, pay for the difference yourself, or apply for a private student loan.  Frequently people choose the latter.  This is where I will say BE CAREFUL!  I would really rather not see you take out a private loan.  Why?  Well, there are a few reasons.  First, private student loans rarely (if ever) offer a fixed rate (federal student loans have a ceiling on rates also, so you won't pay more than about 6.8%).  Usually the interest rate on a private loan is variable.  That means your payment and interest rate can be hiked up at ANY point in time, and you are stuck!  It's a pretty scary prospect.  The second reasons is that they offer very limited (if any) deferment options.  Ideally, when you enter repayment, you won't need to defer.  That being said, life can be unpredictable.  If something terrible happens (unemployment, medical, etc), you don't want to end up in default (that's when you stop paying your loans, and it's terrible for your credit).  You want options!

Taking out a private student loan is a little like playing Russian Roulette.  Admittedly, I took private loans out.  My variable interest rate has been hovering at about 3%, which is great.  The timing has accidentally worked out for me because once the recession hit, loans became somewhat cheap.  That being said, I am making 100% sure to get my last private loan paid off this year.  I don't want to run the risk of being on the wrong side of a rate hike!  I've been accidentally VERY lucky with my private loan, but the truth is that I should have investigated another way of funding the difference that I needed.

Please, please, empower yourself with knowledge when it comes to taking out student loans.  Investigate everything.  There are online calculators that will help you to estimate future payments, etc.  Try to close any financial gaps without resorting to private loans, or the school of your dreams could contribute to a future nightmare!

What questions or experiences do you have with selecting student loans?  Leave questions and comments below!

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