The first question we often times get on calls is: How do student loans work?
As expected, we receive this question from students about to enter their studies as well as those that are already studying.
Ironically, we also get this question from those that have already graduated.
Below, I will discuss how student loans work for all three phases of your academic career:
- Before you begin studying.
- While you are enrolled
- Post graduation
As a note before we get started, before using loans you should take advantage of other opportunities to pay for school such as scholarships and grants.
How Student Loans Work Before You Begin Studying
There are a few steps you need to take before classes begin to make sure you’re ready.
First thing you’ll want to do is fill out your FAFSA form. FAFSA is the form that determines your eligibility to receive loans.
You’ll be notified a few weeks after completing the FAFSA with details on how much federal student loans you’re eligible for.
You will need to contact your school to find out when you’ll receive financial aid because each school is different and on different schedules (semesters vs quarters, start dates, etcc.).
Once loan disbursement happens, a portion will automatically be sent to your school for tuition. If there’s any remaining amount, you will receive a check.
For example, let’s assume you qualify and confirm you want $10,000 and tuition is $6,000. Then $6,000 will be sent to your school and $4,000 to your bank account. You can then use the student loan money on various items you need throughout the school period.
Federal Student Loans Vs Private Student Loans
Do to the way Federal loans work, you’ll always want to get them first. They are cheaper and you have greater repayment options.
However, you can only borrow so much in Federal loans. Therefore, if you still need money, you’ll have to get private student loans.
How Much In Federal Student Loans Can I Borrow?
How student loans work in regards to how much you can borrow is complex. However, I will provide a high level synopsis below.
Each school certifies an amount they believe you need each school period for tuition, books, and cost of living. Therefore, the amount you can take depends on the university you are attending.
However, there are aggregate limits for subsidized and unsubsidized Federal loans (I detail the difference between these two loans in the next section).
The max Federal loans you can take for undergraduate studies is $57,500. Of that amount, the max in subsidized loans is $23,000. This is also broken down into annual limits.
In addition, this amount will very based on being a dependent student or independent student. Basically, if your parents claim you on their tax return, you’ll be eligible for less.
One more item to note, how student loans work for graduate school is different than undergrad. Primarily, you are eligible for Grad Plus loans in addition to the aforementioned loans.
Do You Take Out Student Loans Per Semester?
If you are taking out Federal loans, you complete FAFSA once per year.
Then your loans are disbursed based on your academic year. Therefore, to figure out how student loan disbursement works, you’ll have to ask your financial aid department. You’ll definitely want to do this so you can plan accordingly.
Private student loans traditionally require you to apply every time you want a loan. However, some companies are now allowing you to apply once and have multi-year approval. Therefore, you apply once and you can always get additional funding without having to apply again.
How Do Fees Work On Student Loans?
Yes, the Federal government charges you fees to take out loans.
For subsidized and unsubsidized loans, the fee is 1.057% of the loan balance.
For PLUS Loans (These are for grad school) the fee is 4.228% of the loan balance.
Most private lenders do not charge fees.
How Student Loans Work While In School
How student loans work in school is a lot less complex than getting them or repaying them.
When you’re in school, your federal student loans will be put in deferment if you are a full-time student. Being in deferment will put your student loan payments on pause until you graduate.
However, deferment means two different things based on if your Federal loans are subsidized or unsubsidized student .
Subsidized vs unsubsidized
You are not required to make payments while you are in school. However, you are still charged interest on your loans.
For subsidized loans, the government forgives or “pays” the interest while you are a full time student. Therefore, your loan balance won’t increase.
This is not the case for unsubsidized loans. Therefore, while in school your loan balance increases and the interest charged is based on how much you borrow.
Should I Make Payments While In School?
When borrows hear their loan balance is going to go up, often times they want to start making payments.
However, you may not want to do that if you plan on doing an Income Driven Repayment plan after you graduate do to the way those plans work. Specifically, on those plans you are going for forgiveness. Therefore, making payments in school makes no since.
This topic is one of the biggest reasons why we recommend building a student financial plan. Doing so allows you to determine which repayment strategy you may follow so you can make the right decisions while you are in school.
How Do Private Student Loans Work While I’m In School?
It will depend on where you get the loan and the type of private loan that you get.
Therefore, be sure to know the terms of your private loan before signing off on it.
Also, if you don’t have to make payments while you are in school, then all private lenders will charge interest on your loans and 100% of it will be added to your loan balance.
What GPA Does FAFSA Require?
One big item to note. If your GPA falls below 2.0, you no longer qualify for FAFSA. Therefore, you’d have to get private student loans.
How Student Loans Work After You Graduate?
Once you graduate, you will have a six month grace period before you have to make a payment on your Federal student loans.
You only get one six month grace period. Therefore, if you graduated from undergrad school and took a year off then went to grad school you will not get an additional six month grace period on your undergrad loans.
For private loans, you may or may not receive a grace period. Again, each company is different so be sure to read the docs before signing.
How Federal Student Loan Repayment Works
Once your grace period is up on your Federal loans, you’ll need to pick a repayment plan.
There are nine different repayment options you can pick between.
To make it easy, at FitBUX we break these nine different plans into 2 different strategies. The payoff strategy or loan forgiveness strategy.
The payoff strategies are essentially how you’d typically think about paying off a loan. The goal is to pay them off ASAP.
However, there are loopholes you can take advantage of and you’ll also want to look into student loan refinancing.
The loan forgiveness strategies, also called income driven repayment, are the exact opposite of how the payoff strategies work.
You’re essentially trying to pay as little as you can and aggressively save money.
There are a lot more variables with loan forgiveness strategies such as your income, marriage status, loan amount, and future income.
Not only do you have all these variables but you also have to worry about a big tax bomb at the end of these loan forgiveness plans.
This is going to be crucial because sometimes that tax is a large number.
For some reason, how student loans work is an extremely confusing topic. To be clear, the Federal government has made it extremely confusing when it doesn’t need to be.
This article was created to guide you through the major topics you need to know in regards to how student loans work.
However, we know it can be confusing. In addition, after you read something you may still have a hard time figuring out how to apply it to yourself.
Therefore, FitBUX is here to help navigate these uncharted waters with you.
We have developed a financial planning technology and service designed specifically for student and new grads, aged 20 – 40. We can help you plan while you are in school and for those that already graduated we can help you as well.
Become a member by signing up at Fitbux.com. We’re looking forward to helping you.
By David Hughes and Joseph Reinke, CFA