What are the things to know about a student loan in the USA before borrowing?
Taking out student loans can be necessary to pay for college and open doors for your future. But borrowing also comes with serious financial burdens if not approached carefully.
Before signing any promissory note, understand the key factors about student loans in the USA.
This article will highlight ten essential things to know about a student loan in the USA before borrowing.
Read Also: Student Loan Refinance Rates
10 Things to Know About Student Loan USA Before Borrowing
Here are 10 of the most important things to know about a student loan in the USA before borrowing:
1. Understand the Difference Between Federal and Private Student Loans
The first major decision is whether to utilize federal or private student loans. The government funds federal student loans through programs like Direct Loans and Perkins Loans.
Banks, credit unions, and online lenders issue private student loans. Federal and private loans have vastly different terms, protections, and requirements.
Over 90% of current student loan debt is in federal loans. Prioritize federal borrowing options first before considering private loans.
Federal Student Loan Benefits
- Lower interest rates, currently ranging from 4.99% to 7.54% for undergraduates
- Fixed interest rates mean predictable monthly payments
- Numerous flexible repayment plans based on income and family size
- Options to postpone payments through deferment and forbearance
- Discharge or forgiveness is available in some circumstances
- No credit check or cosigner is required for most federal loans
Private Student Loan Considerations
- Generally have higher variable interest rates from 3% up to 15% or more
- Fewer built-in options for payment postponement or discharge
- It may require a credit check and minimum income or cosigner
- Loan terms and protections can vary widely between different lenders
- May charge fees for origination, late payments, or prepayment
Before considering private borrowing, maximize federal direct and Perkins loans in your name first. This ensures you get the best terms and options.
2. Understand Interest Rates, Fees and Costs
The interest rate on your loan has a massive impact on the total amount you will eventually repay.
Current interest rates for federal undergraduate student loans range from 4.99% to 7.54% depending on factors like dependency status and year in school.
Private loan rates can range from around 3% to over 15% or more, depending on your credit. It pays to compare rates from multiple lenders.
Federal student loans do not charge origination fees or prepay loans early. However, many private lenders charge borrower fees added to the principal or deducted from disbursements.
This increases costs further. Always factor the interest rates and fees into the total costs before borrowing.
3. Borrow Only What You Need for College
One of the biggest student loan mistakes is borrowing more than necessary for college. Avoid this by calculating your total costs and then subtracting expected money from other sources like:
- Savings accounts and college funds
- Annual income and summer or part-time earnings
- Scholarships, grants, and tuition assistance
- Family contributions or gifts
- Tuition reimbursement or assistance from the employer
You should aim to borrow the remaining amount left over in student loans. Make sure to factor all costs like tuition, housing, meal plans, books, supplies, transportation, and personal expenses into your college budget.
Over-borrowing leads to paying more interest and increased loan payments down the road.
4. Understand the Different Types of Federal Loans and Annual/Aggregate Limits
The main federal loan programs include Direct Subsidized and Unsubsidized Loans, Direct Plus Loans for parents and graduate students, and Perkins Loans.
Each has specific eligibility criteria, annual and lifetime borrowing limits, interest rates, and terms for repayment. Two key factors that impact limits are your dependency status and what year of study you are in.
Dependent undergraduates can receive the following:
- Up to $5,500 in Direct Subsidized & Unsubsidized Loans per year
- Total aggregate limit of $31,000
Independent undergraduates qualify for the following:
- Up to $9,500 in Direct Subsidized & Unsubsidized Loans annually
- Total borrowing up to an aggregate of $57,500
Knowing the loan types, limits, and terms helps maximize the best options.
5. Understand All Repayment Plans and Flexible Options
The standard repayment plan for federal student loans is fixed monthly payments for ten years.
However, alternative repayment plans can also help lower or adjust payments based on your income and family size. Options include:
- Income-Based Repayment (IBR) – Monthly payments capped at 10-15% of discretionary income. Forgiveness after 20-25 years of payments.
- Pay As You Earn (PAYE) – Payments are capped at 10% of discretionary income. Forgiveness after 20 years of payments.
- Revised Pay As You Earn (REPAYE) – Payments capped at 10% of discretionary income. Forgiveness after 20-25 years of payments.
- Income-Contingent Repayment – Payments are 20% of monthly discretionary income or fixed payments for up to 25 years.
- Extended Repayment – Fixed or graduated payments over 25 years for higher loan balances.
- Graduated Repayment – Payments start low and gradually increase every two years over the term.
Enrolling in an income-driven plan can provide flexibility when facing financial hardship. You can change plans annually for free if your situation changes.
6. Make Use of Deferments and Forbearances if Necessary
Federal student loans offer deferment and forbearance options to temporarily postpone payments for up to 3 years if you meet certain criteria.
- Deferment pauses payments and postpones interest on subsidized loans. Interest still accrues on unsubsidized loans.
- Forbearance pauses or reduces monthly payments for up to 12 months. Interest continues accruing.
These provide an important safety net but are used judiciously. Delaying payments extends the loan repayment term and increases total interest costs over the life of the loan.
7. Know the Pros and Cons of Student Loan Consolidation
Consolidating combines multiple federal student loans into one new Direct Consolidation Loan.
This can simplify repayment by having just one monthly bill. However, there are some key downsides:
- Loses special benefits attached to underlying loans like interest subsidies and grace periods.
- No reduction in total interest paid over the life of loans.
- Monthly payment may increase if the term is beyond ten years.
- One-time option: cannot reconsolidate loans later.
Consolidation can help manage payments but does not typically lower interest costs. Evaluate carefully if it aligns with your goals and financial situation.
8. Understand Conditions for Federal Student Loan Forgiveness
Certain circumstances allow for federal student loans to be forgiven or discharged tax-free. Make sure you know these options if facing financial hardship.
- Total and Permanent Disability Discharge – Federal loans discharged if disabled and unable to work.
- School Closure Discharge – Loans are forgiven if the school closed while enrolled or shortly after.
- Borrower Defense to Repayment – Loans are forgiven due to the school committing fraud.
- Public Service Loan Forgiveness (PSLF) – Forgiveness of loans after 120 payments while working full-time for an eligible employer.
- Teacher Loan Forgiveness – Up to $17,500 forgiven for meeting service requirements as a full-time teacher in certain low-income schools.
- Income-Driven Repayment Forgiveness – Any remaining balance is forgiven after 20-25 years of payments in those plans.
9. Stay Out of Delinquency and Avoid Default
Doing everything possible to avoid missed or late student loan payments is critical. Delinquency is when payment is 30-270 days past due. Default occurs when 270 days are past due.
Consequences of default include:
- The entire loan balance and interest are immediately due
- Up to 15% collection fees added
- Wages garnished without a court order
- Federal and state tax refunds seized
- Credit score plummets, making borrowing difficult
- Ineligibility for future aid and student loans
Avoid default at all costs. Use options like deferment, forbearance, income-based repayment, or loan rehabilitation if struggling to make payments. Communicate with your servicer right away if you anticipate issues paying.
10. Make Use of Student Loan Tax Benefits
There are some tax benefits at tax time that can help lower the costs of your student loans:
- Student loan interest is deductible up to $2,500 annually on federal income taxes for those under $85,000 per year or $175,000 for married couples.
- Employers may contribute up to $5,250 annually to employee student loans tax-free through an educational assistance program.
- Loans forgiven under certain circumstances are not counted as taxable income.
Learning about deductions, employer contributions, and when loan cancellation is tax-free can save you money each year if you are eligible.
Making wise borrowing decisions requires homework on student loan options and responsibilities.
Follow this advice before taking on debt to keep college affordable now and financial options flexible in the future.