If you’re about to head off to college or graduate school, you’re likely wondering how you’ll pay for it. While it’s best to avoid student loan debt as much as possible, taking out loans has become an inevitable reality for the majority of today’s students. A U.S. News & World Report survey found that two-thirds of 2017 graduates took out loans to pay for college – and that percentage is likely to increase as the cost of college continues to rise.
Before you consider borrowing to cover college costs, be sure to max out all other forms of aid. That includes scholarships and grants, work-study opportunities, and any savings you or your family set aside for the purpose. Although many financial experts consider student loans to be “good” debt, any debt has the potential to limit your financial future.
If you find yourself still needing to borrow money for school, as the majority of students do, it’s crucial to weigh your options. Not all student loans are created equal. Taking out the right kinds of loans is a key part of being able to manage your student debt after graduation. Here’s what you need to know to weigh your options.
Federal Government Loans
Federal student loans are those provided by the federal government, whereas private loans are provided by banks, credit unions, and some states.
Types of Federal Loans
There are three main types of federal student loans: direct subsidized, direct unsubsidized, and direct PLUS loans.
Direct Subsidized Loans
With a direct subsidized loan, the government pays the interest on your loans while you’re in school, during your grace period after graduation, and during any deferment periods.
Subsidized loans are available for students who demonstrate financial need. Your school will be able to tell you if you qualify after you fill out a Free Application for Federal Student Aid (FAFSA).
Because of their potential to save student borrowers a significant amount of money on interest, you should always accept subsidized loans before any others. Unfortunately for graduate students, subsidized loans are only available for undergraduates.
Direct Unsubsidized Loans
When you take on a direct unsubsidized loan, you are responsible for paying any and all interest that accrues. Interest begins to accrue the second your loan is disbursed, accrues the whole time you’re enrolled, and continues accruing for the life of the loan until you pay it off. It also accrues through any grace periods or deferments.
After you graduate and your grace period has expired, all the interest that accrued on the loan while you were in school will capitalize. That means it will be added to the principal balance – the original amount borrowed – and you’ll start earning interest on the new balance.
Parent PLUS Loans
Because there are limits on how much a student can borrow in government loans, many parents find themselves taking on student loans for their children. On the federal level, these come in the form of parent PLUS loans. Parent PLUS loans are specifically for parents with dependent undergraduate students.
Be careful if you’re a parent considering taking on a parent PLUS loan. Although they can be useful to help cover the costs of your children’s education, it’s easy to get in over your head with them. There are no specific caps on PLUS loans; you can borrow as much as you need up to the school’s certified total cost of attendance. That includes tuition and fees, room and board, and books and supplies, minus any other financial aid your child receives.
But PLUS loans operate more like private loans than federal ones. They come with higher interest rates and origination fees, and they require a credit check, which means your credit history must be excellent to qualify.
Grad PLUS Loans
Like parent PLUS loans, grad PLUS loans are an additional source of funds for graduate and professional students that extend beyond the borrowing limits of federal subsidized and unsubsidized loans.
As with parent PLUS loans, there are no caps on borrowing except for what your school certifies as the total cost of attendance.
Unlike federal subsidized and unsubsidized loans, grad PLUS loans require a credit check, so you must have good credit to qualify. Your credit history must be free of any negative items, such as bankruptcies, charge-offs, or debt that’s in collections. If your credit is less than stellar, it’s possible to apply with a cosigner.
Because all PLUS loans come with higher interest rates than other government loans, make sure to max out your federal subsidized and unsubsidized loans before turning to a PLUS loan.
How Much Can You Borrow?
The maximum amount of federal loans you can borrow depends on several factors: your year in school, your status as a dependent or independent student, and the type of loan. There are limits on how much you can borrow per year, as well as how much you can borrow in total. Total limits for graduate borrowers include any amount borrowed as an undergraduate.
As mentioned, there is no set cap on PLUS loan borrowing. However, your school will determine a “total cost of attendance” amount, and you won’t be able to borrow beyond whatever that limit is.
The following borrowing limits are for Federal Direct Unsubsidized and Federal Direct Subsidized loans only.
Borrowing Limits for a Dependent Undergraduate Student
A dependent undergraduate student can borrow from $5,500 in their first year up to $7,500 in their third year and beyond. That includes both federal direct subsidized and unsubsidized loans. The total aggregate amount a dependent undergraduate can borrow is $31,000.
To be classified as a dependent, you must be under the age of 24 as of December 31st of the year aid is awarded, even if your parents don’t support you financially and can’t or won’t help you pay for college. However, if your parents are ineligible to borrow a parent PLUS loan, you may be able to borrow beyond the caps for a dependent student.
Borrowing Limits for an Independent Undergraduate Student
You are considered independent if you’re over the age of 24, or if you’re under 24 and:
- Are married
- Have dependents
- Are an orphan
- Are a veteran or active-duty member of the U.S. armed forces
Independent undergraduate students can borrow more money than dependent students – anywhere from $9,500 in their first year up to $12,500 in their third year and beyond. The total amount they can borrow is $57,500.
Borrowing Limits for Graduate & Professional Students
Graduate and professional students are, by nature, classified as independent, regardless of age. Not only is there no expectation that parents will help foot the bill for graduate school, but borrowing limits are higher because graduate and professional school can be much more expensive than an undergraduate education.
A graduate or professional student can borrow up to $20,500 during any year they are enrolled in school and up to $138,500 in total. That includes any amount already borrowed to pay for undergraduate schooling.
Advantages of Federal Loans
If you must borrow to pay for school, there are a variety of advantages to borrowing through federal loan programs.
- They Typically Have Lower Rates and Fees. Every year, Congress determines a legal limit on the amount of interest that can be charged on federal student loans. This limit is typically lower than interest rates private lenders offer. Federal loan interest rates are also fixed over the life of the loan.
- You Can Consolidate Them. After graduation, you can consolidate all your federal student loans into one new loan with one monthly payment and interest rate. That can greatly simplify your loan repayment process.
- They Offer Extensive Financial Hardship Options. If you suffer economic hardship, you can defer payments on a federal loan for up to three years, and interest is paused on any unsubsidized federal direct loans during this time. Few private lenders offer more than 12 months if they offer deferment at all. If you run out of deferment ability, federal loans also have extensive forbearance options. During forbearance, all federal loans accrue interest.
- Their Default Terms Are More Generous. If you fall behind with your payments, federal loans give you extra time before you’re considered in default. You won’t be reported to the credit bureaus or considered delinquent until you miss three months of payments, and your loans won’t go into default unless you miss nine months of payments. A private lender can consider you in default after as little as one missed payment.
- They Offer a Wide Variety of Payback Options. With several repayment options, including consolidation and income-driven repayment (IDR) plans, federal loans are easy to work with if you fall on hard times. If you have a low-income job or are unemployed and can no longer defer your loans, you could qualify for a $0 monthly repayment by enrolling in an income-based repayment (IBR) plan. Even better, those $0 monthly payments count toward your 20- to 25-year forgiveness clock (more on that below).
- They Can Be Forgiven. If you borrow a large amount in student loans and enroll in a qualifying IDR program, you may be eligible to have the balance of your loans forgiven in 20 to 25 years. If you work full-time in a public service job, you may also qualify to have your loans forgiven even sooner through the Public Service Loan Forgiveness (PSLF) program.
- They Can Be Cancelled or Discharged. If you or your school meet certain criteria, you’re eligible for loan cancellation or discharge. Criteria include discharging your loans in bankruptcy, becoming totally and permanently disabled, dying, school closure, or your school being found to have made false promises.
- They Don’t Require Good Credit or a Cosigner. Except for PLUS loans, federal loans don’t require a credit check, which means you don’t need a cosigner or even good credit to apply. That’s helpful for many undergraduate students who haven’t yet established credit history.
Disadvantages of Federal Loans
Although federal loans are generally preferable to private ones, they do come with some disadvantages.
- There Are Caps on How Much You Can Borrow. The average cost of tuition at a private university during the 2018 to 2019 school year was $35,676. Yet a first-year undergraduate may only borrow federal direct subsidized or unsubsidized loans up to $5,500. That’s insufficient for many families, forcing them to turn to less attractive borrowing sources, such as PLUS and private loans.
- You Can’t Discharge Them in Bankruptcy. Unless you can prove that paying back your loans is an “undue economic hardship,” you can’t discharge federal loans in bankruptcy. Proving undue hardship is extremely difficult no matter your income or the size of your debt.
- The Government Can Garnish Your Wages Without Having to Sue First. If you default on your federal student loans, the government can automatically garnish your wages or capture your tax refunds or Social Security benefits without having to sue you. However, with so many options for paying back your student loans, there’s little reason to find yourself in this situation.
- PLUS Loans Are More Like Private Loans. Unlike other federal loans, PLUS loans require a credit check. They have higher interest rates and fees than other federal loans, and parent PLUS loans have fewer repayment options. Because of this, parent borrowers may find a better deal through a private lender, especially if they have excellent credit.
How to Apply
To apply for federal student aid, you’ll need to complete the FAFSA. Nearly 19 million students do this every year, according to Finder.com’s most recent FAFSA statistics. The FAFSA is your application for all federal loans, as well as any need-based aid, such as federal grants, work-study, and certain scholarships
After you submit your FAFSA, you’ll get a Student Aid Report outlining your expected family contribution (EFC). You don’t have to pay this amount out of pocket for your education. However, your EFC is the amount the federal government expects your family – or you if you’re a graduate student – to be able to pay, regardless of whether you intend to contribute anything. Your school uses this amount to determine how much aid, including student loans, you’re eligible to receive.
Be sure to fill out a FAFSA at the same time you apply to schools, and include the schools you’re applying to in your application. That way, when you receive your college acceptance letters, you’ll also get a financial aid award detailing which types of aid you qualify for.
Before you consider private loans, make sure you’ve maxed out all other sources of aid, including federal loans. Private student loans – which are made by banks, credit unions, and other financial institutions – don’t offer the same level of borrower protections or repayment options as federal loans.
If you need additional aid after exhausting all other sources, or you’re in a position to get a better interest rate with a private loan and know you won’t need the protections of federal loans, private loans are an option to consider.
Types of Private Student Loans
Private student loans exist for all kinds of purposes, including covering living expenses, medical school costs, and bar exam preparation. To find private loans that fit your needs, try an online tool such as Credible. Credible allows you to compare options across a wide variety of lenders. You only need to complete one application to receive personalized offers from multiple lenders. The process is free and doesn’t impact your credit score.
Some of the top student loan lenders include Ascent, Citizens One, College Ave, CommonBond, Discover Student Loans, LendKey, Navy Federal, PNC, RISLA, and Sallie Mae. Each has its own loan types, rates, terms, and borrowing caps.
How Much Can You Borrow?
Borrowing limits vary by lender. Some lenders don’t allow the amount you borrow to exceed the school’s certified total cost of attendance. Others allow you to borrow money above and beyond this cost. If you’re a graduate, medical, or law student and you need more money than your school will certify, private loans can help. While a Grad PLUS loan cannot exceed the school-certified cost of attendance, private loans can.
Additionally, PLUS loans aren’t available for undergraduate borrowers, so several private lenders have stepped in to fill funding gaps left by federal loan caps. And private loans may offer better rates than a Parent PLUS loan for parent borrowers with excellent credit.
Don’t Borrow More Than You Can Reasonably Afford
Keep in mind that just because you can borrow a certain amount, that doesn’t mean you should. Do everything you can to avoid as much student loan debt as possible.
Virtually all of the student borrowers who owe over $100,000 in student loan debt borrowed to obtain advanced degrees. But not all advanced degrees are created equal. For example, according to the Bureau of Labor Statistics (BLS), medical doctors earn a median income of $208,000 per year, which may make borrowing large sums of money for school feel worth it. Lawyers, however, earn a median annual income of about half that at $122,960. And the median income of a college teacher, the primary career choice of Ph.D. students, is a mere $79,540 per year. That makes borrowing large amounts for these degrees seem less worthwhile.
So before you borrow six figures or more in student loans, consider what your future earnings might be to determine how easily you’ll be able to pay back the loans. And when it comes to borrowing private money, keep in mind that you won’t have options such as IDR or forgiveness to fall back on if you run into trouble.
Advantages of Private Loans
For all their downsides, private student loans do offer the following benefits.
- They Can Cover Gaps in Financing. Again, make sure you exhaust every other resource before turning to a private student loan. But if you’ve done so and still need additional money, a private student loan can address this need.
- You Can Borrow Money for Specific Purposes. Private lenders offer a much wider variety of loan types than the federal government. Because of this, you can find private loans that specialize in funding everything from bar exam expenses, such as prep classes and application fees, to international study. Private lenders also offer medical school loans at lower interest rates than federal loans for those with good credit.
- Some Have Better Interest Rates Than Federal Loans. Parents with excellent credit looking to borrow money to fund a dependent undergraduate may find a better deal with a private lender than with a PLUS loan. However, if their score is lower than 700, they’re probably better off with a PLUS loan.
- You Can Refinance Them. After you graduate and have established a good credit history and credit score, you may be able to save money by refinancing with a private lender. When you refinance, the lender pays off your current loans and issues you a new loan with a new interest rate and terms. A lower interest rate and lower monthly payment are the primary reasons for refinancing. However, you’ll need a credit score of at least 700 to qualify for refinancing with most private lenders.
Disadvantages of Private Loans
The disadvantages of private student loans are numerous and can be severe. Financial experts recommend exhausting your options for other sources of aid before turning to private loans.
- They Require Excellent Credit. Private loans require a good credit history and a credit score of 700 or higher. That puts private loans out of reach for most undergraduates since few have established credit histories.
- Applicants Without Excellent Credit Need a Cosigner. While the ability to add a cosigner to your application may seem like a plus, cosigning has risks. If the student borrower becomes unable to pay back the loan, the cosigner is obligated to do so. And while some lenders have an option for a cosigner release, the process is often complicated. The Consumer Financial Protection Bureau sued Navient, a private student loan servicer, over this very issue.
- Interest Rates Are Based on Your Credit History. Although private lenders advertise interest rates as low as half that of federal loans, only borrowers with the highest credit scores qualify for these rates. For borrowers with lower credit scores or no credit history, interest rates could be as much as double or more the legal limit for federal loans.
- There Are No Legal Limits on Interest Rates. While lenders attempt to stay competitive with each other by offering a similar range of interest rates, there is no set legal limit on what they can charge. They can raise your rates for late payments just as credit cards do. And their rates are often variable, which means they fluctuate with market conditions.
- Interest Starts Accruing Immediately. Unlike federal subsidized loans, private student loans start accruing interest as soon as they’re disbursed to you. After you graduate and your repayment grace period expires, the interest capitalizes.
- They Offer Limited Options for Economic Hardship. Private student loans have much less generous terms for economic hardship than federal loans. You’ll likely be paying off your student loans for a decade or more, and there’s no telling what life events may occur. Even if you lose your job through no fault of your own, you’ll still be held accountable for paying back your private loans.
- They Can’t Be Forgiven. For students who borrow over $100,000, student loan forgiveness may be crucial, and it’s something private loans don’t offer. Private lenders provide no options for Public Service Loan Forgiveness.
- They Have Less Generous Default Terms. The consequences of missing payments on private loans can be severe. Some private loans go into default the second you miss a payment, which means they’re immediately reported to credit bureaus and potentially put into collections. When this happens, your loan becomes due in full. Your interest rates can also go up as a result of missed payments, and the lender can sue you. What’s worse, the lack of repayment options such as deferment and IDR means that missing a payment is likely for borrowers who fall on tough times.
- You Can’t Discharge Them in Bankruptcy. While it’s extremely tough to discharge federal student loans in bankruptcy too, the lack of repayment options for private loans makes it more likely that borrowers will default if they fall behind. A default can trigger lenders to sue borrowers and their cosigners, and a judgment could result in wage garnishment, no matter your economic situation or ability to repay.
- Many Loans Can’t Be Discharged If You Die. If you die owing money on a private loan, that debt becomes a creditor against your estate. If you borrowed with a cosigner, they become responsible for paying the balance on your loan even after you’re gone. Fortunately, many lenders now offer death discharge, but make sure to read your lender’s fine print before signing for a loan.
How to Apply
You apply for a private student loan directly through the bank or financial institution you’re looking to borrow from. If you use Credible, you’ll be able to input all your personal information once and receive up to nine prequalified rate quotes in just minutes.
Each lender has its own requirements, but in general, private loans require a full underwriting process. Private lenders want to see your credit score, credit report, and proof that you have or will have a well-paying job and the means to pay back the loan. If you don’t meet these basic requirements, you’ll need to apply with a cosigner.
Because there are so many private student loan options, it’s important to compare lenders. A variety of factors differentiate private loans, including interest rates and fees. Other important factors to look out for include borrower protection options, whether the loan offers a cosigner release, and if there are any perks, such as lower interest rates for students with good grades.
Which Type of Loan Is Best For You?
You shouldn’t even consider taking out a private loan to help cover the costs of school unless you are entirely out of other options. The disadvantages are too severe, and if you’re not careful, you could find yourself in serious financial trouble.
If you miss payments or go into default on a private student loan, your credit score will plummet, making it nearly impossible for you to buy a car, get a mortgage, or even lease an apartment. And since it’s nearly impossible to discharge any student loan in bankruptcy, you can’t escape your monthly payments, even if making them becomes a severe hardship.
On the other hand, should you ever fall into hard times and become unable to make your monthly payments on a federal loan, you have a variety of repayment options, including completely pausing payments through deferment or qualifying for $0 payments through IBR.
That makes just about any federal loan a better option than private loans, even if you have the credit to qualify for a better interest rate on a private loan. Turn to private loans only after you’ve maxed out every other option.
Exercise Caution Before Taking Out Any Loan
Turn to federal loans only after you’ve exhausted all resources for “free” aid, such as grants, scholarships, work-study, and your own savings. There’s a reason student loan debt is called a crisis in America; it’s crippling many families’ financial futures.
According to Pew Research Center, nearly half (48%) of student loan borrowers report that making their loan payments is a financial hardship, and only 27% say they’re living comfortably. Student loan payments make it difficult for 25% of borrowers to buy a home, impact career choices for 24% of borrowers, and 7% of borrowers put off marriage or starting a family because of their payments.
Debt can quickly become a financial prison that limits your options for creating the life you desire. Unfortunately for the vast majority of students, borrowing money to pay for school is unavoidable. But if your debt ends up overcoming your ability to repay it, college and graduate study will feel unworthy of the investment.
So regardless of whether you borrow federal or private money, make sure you can manage the monthly payments. Use calculators such as the one at FederalStudentAid to find out what your payments will be and how long it could take for you to pay a loan back. Weigh that information against the possibility of you finding a job and what your potential salary might be. Look up your industry on a site such as Glassdoor to get an idea of your salary potential.
Again, just because you qualify to borrow a certain amount, that doesn’t mean you should. Always exhaust any other kind of financial aid, as well as your own savings, before taking on debt, as any kind of debt can have severe consequences and there’s nothing like the freedom of being debt-free. Although many financial experts classify the money you borrow for college as “good” debt, it can turn into the worst kind of debt if you get in over your head.
I have many regrets about borrowing more for my Ph.D. than I could ever have repaid on my teaching income. And although I borrowed far more in federal student loans than I did in private ones, it’s the private loans I most regret because of the lack of repayment options.
So try to borrow as responsibly as possible. Only borrow student loans after you’ve exhausted all other resources, borrow federal loans to the maximum amount you can before turning to private loans, and borrow only as much as necessary.