Student Loan Debt: Know Your Options Before You Act

You’ve been accepted to your favorite college or university and are ready to jump in and begin learning new things. Then you start to think about how you’ll cover the cost. First, apply for any scholarships you would be eligible for. That’s free money! Then apply for federal loans by completing the Free Application for Federal Student Aid (FAFSA). You’ll have to enter a lot of personal and financial information (and repeat this every year) which determines how much you and your family can contribute to college costs. They’ll notify you of the types and amounts of federal grants, loans and/or scholarships that will be available from the government. 

If you still need additional funds to pay for school, your next option is usually private education loans. As the name implies they are not from the federal government and the loans are made by banks or other private financial institutions. The terms are set by the lender (and not guaranteed or subsidized by the government). Most private student loan programs may require a cosigner since the borrowers are so young. The lender usually confirms the borrower’s enrollment and the amount needed with the university. Private student loan borrowers are not required to file FAFSA, however, it’s recommended to file it anyway ensure you receive all of the federal funding possible before turning to private sources. Why? Federal loans come with more generous repayment and forgiveness options compared with private loans. 

Student loans are considered unsecured debt (no collateral backing it up) and the interest rates will vary by the type of loan. For federal loans, the Department of Education sets the loan rates (including a rate cap) for each school year and these rates apply to all students regardless of credit history. Private lenders, on the other hand, set rates based on the creditworthiness of each applicant (and co-signor) by reviewing factors such as credit score, job history and income. Interest rates are typically lower on federal loans than on private loans. However, private lenders may offer variable interest rates which may get you a lower rate than a fixed-rate loan initially, but it could always increase later. 

When you’re finished with school, you may have multiple federal and private loans at different interest rates, with different and terms. It’s common to wonder if you should consolidate and/or refinance them. First, get familiar with the type of loans that you have so you can make the best decision for your situation. Consolidation combines federal loans (and only federal loans) into a single loan, and can be done by applying with the federal government. You’ll receive a new consolidated rate that is a weighted average of your existing federal loans and a new term. You can’t get a better interest rate by consolidating. Refinancing is done by a private lender and can combine either private loans, federal loans, or both. It requires a credit application and is most often done to get a lower interest rate and/or extend the length of the loan and therefore lower the monthly payments (though this does mean you’ll pay more in total over the life of the loan due to additional interest). Before making a final decision on refinancing, remember that federal loans may have some special features (grace periods, forgiveness programs, income based repayment plans,etc) that you will lose if you refinance. So pay close attention to what you stand to lose, not just what you might gain.

If you have trouble making your payments, don’t just stop paying. That would severely impact your credit for a long time. Reach out to your loan servicer and discuss your hardship. They may be able to offer you relief until you are back on your feet. Student debt can be considered a good debt since it serves a bigger purpose (preparation for career and future earnings), but as with any debt, you should always find ways to minimize the amount and only borrow what you absolutely need.