When was the last time you actually read through the full terms and conditions on a smartphone lease, subscription service, or user agreement? Yeah, me too.
The thing is, while those long and often hard to read terms and conditions clauses can seem like a pain, they actually contain important information about your relationship to the issuing organization, not to mention what your rights and responsibilities are if problems arise.
When it comes to student loans, in particular, knowing what's buried in the fine print can make a big difference. There are many different kinds of student loans, each with its own set of features and rules. While all student loans offer money for higher education expenses, where they can differ dramatically is in the amount of interest you'll pay on top of the borrowed amount, how that interest gets calculated, how big your monthly payment will be, and how much time you will have to pay it all back. Student loan terms and conditions also often spell out what happens if you can't make your payments, and what, if anything, you can do about it.
To avoid any nasty surprises after graduation, it's important to understand what you're getting yourself into when you sign a student loan agreement. Learning about the ins and outs of student loans now can help you be better prepared to make smart financial aid decisions.
Types of Student Loans
There are two main types of student loans: federal and private. Federal student loans are loans offered by the government, which means their terms and conditions are set by law. Federal loans have a lot of benefits that private loans don't, including the ability to wait until after graduation to start repaying the loan, a range of repayment plans, and even postponement options if you have trouble making your payments. Based on financial need, you may also qualify for what's called a subsidized loan, which is where the government pays the interest on your loan for you while you're in school.
Private loans, on the other hand, are loans made by banks, credit unions, and some state-affiliated organizations. On this type of loan, the terms and conditions are determined by the lender. While private loans may be very similar to federal loans in a lot of ways, in many cases they are often more expensive (offered at a higher interest rate), require a credit check, and might require you to make payments while you're still in school.
The type of student loan you're able to get may depend on a range of factors, including you or your parent's income, your credit history, and more. If you are offered a choice, it's important to weigh your options carefully and consider the long-term consequences of student loan debt before making a decision.
Demystifying Interest Rates
All student borrowers are charged interest on their loans. The amount of interest that gets added to the original amount you borrow depends on whether your loan has a fixed or variable interest rate. Interest rates as a whole go up and down all the time. If you have more than one student loan, chances are each loan was offered at a different rate, but there are some additional differences to be aware of.
Federal loans typically have a fixed interest rate, which means the interest rate will stay the same from the moment you signed the loan documents until you make that last payment. While this interest rate might be higher than a variable rate, it is more predictable, which is something many borrowers like. Month after month, year after year, you'll know exactly how much your loan payment is, so you'll be able to budget accordingly.
In contrast, a variable interest rate is just what it sounds like: a rate that goes up and down every quarter or even every month, depending on what the market rate is at the time. Why this makes a difference is that when the interest rate changes, the amount of interest charged on your loan also changes – and so does the amount of your monthly payment. While many borrowers choose the variable interest rate expecting it to be lower than a fixed rate – and it often is – it could change at any time. This makes loan payments on a variable interest loan more difficult to predict in the long term.
After the graduation celebrations are over, it's time to get to work and repay your student loans. This is where many borrowers realize they've dug themselves in a little too deep. Student loans are easy to ignore while you're busy taking classes, especially if your loans do not require you to make payments until after you graduate. Once reality hits, however, and repayment begins, the effects of your loan choices may become a formidable fact of life.
The exact timing of when repayment begins varies depending on the type of loan(s) you have and the terms and conditions that govern each one. For example, federal loans typically have a 6-month grace period after graduation before repayment begins. For private loans, when repayment begins will depend entirely upon what the lender decides. Some loans will enter repayment immediately upon graduation while others may even require payments while you're still in school. Some borrowers prefer to make payments before graduation, as it shortens the loan repayment period overall. Others don't have enough income to manage a loan payment on top of their other expenses.
Repayment terms, or the amount of time you have to repay your loans, are also outlined in your loan documents. Federal student loans have a range of repayment programs that can reduce the amount you pay each month, or even tie your payment amount to your income. Such programs will increase or decrease your payment as your income goes up or down, an option that is attractive to many borrowers. However, it's important to understand that such programs may extend the number of years it will take to pay off your loans, with many federal repayment programs setting total loan forgiveness after 25 years of on-time payments. The repayment schedule on private loans will vary, but as a whole they tend to be far less flexible when it comes to choosing how much you want to pay each month.
Opting for a shorter repayment term may save you a significant amount of money on interest thanks to typically lower rates, but your monthly payment will probably be much higher. Of course, your road to loan payoff is much shorter, which means you'll be free of that student loan debt far more quickly than many other options.
Making extra payments is another way to reduce your debt faster. As your principle amount decreases, so will the amount of interest you'll pay.
Managing Your Loans
Although it may seem like once you've signed those loan documents you're stuck for life, there are several options available that may make your student loan debt more manageable. For example, if you have more than one federal loan, you can apply for loan consolidation. Consolidating student loans means you are essentially combining your smaller loans into one large loan with one loan payment. This can make loan repayment much easier to manage. When you consolidate, however, the government will take an average all of the interest rates on your existing loans and make that your new interest rate for everything. What this means is if you have several loans with different interest rates, some of the rates may go up while others may go down. In this way, you may save money or end up paying more interest over the life of the loan.
If you have private loans, or even if you have a mix of private and federal loans, your main route to simplifying your loan repayment is through refinancing. When you refinance, your lender will pay off all of your existing loans and issue you a new loan in the same amount. While refinancing may give you a lower interest rate, your ability to refinance may be based on your overall credit history. If you don't have a strong credit history or have made a few financial mistakes in recent years, refinancing may not be possible.
In the end, choosing a student loan and a repayment plan all depends on what your priorities are and, to some degree, what options are available to you. No matter how you decide to finance your education, making smart choices about your student loans now – and reading the fine print before signing any loan documents! – can absolutely mean the difference between a bright financial future and a lifetime of crushing debt.