Just about every young person going to college is staring down a tough reality: their future career is probably going to start in debt. College fees are incredibly high in the US, before even taking into account the costs of residence and textbooks. Millions of young Americans take on student loans every year, which has led to a debt crisis that is guaranteed to be part of every political debate.
Over 44 million Americans owe $1.5 trillion in student debt. That number is significant even after you divide it – it translates to about $34 thousand per person. Unfortunately, the number is only growing, and if you’re about to start college, you are probably going to contribute to it.
As hard as you and your parents work, chances are you still won’t come close to covering the cost of tuition. Student loans are a necessary evil. Part of the problem is that figuring out the ins-and-outs of student loans is itself not all that easy. There are a number of different kinds of student loans, and the average high school graduate knows very little about them.
To help get you started in looking for the best student loans, we’re going to break down the differences between the two main types: federal and private.
The Basic Definitions
Understanding the basic definitions of these types of loans is easy. Private loans are provided by (generally) for-profit organizations, while federal loans are provided by the government. Most people understandably assume that going with a federal loan is the best option, considering that the government makes more allowances for people with student debt. However, there are advantages to going with a private loan.
We’ll start by looking at the pros and cons of federal student loans.
Federal Loans: The Good and The Bad
Federal student loans really are the intuitive option for the vast majority of students. There are a number of reasons for this:
- fixed interest rates: no matter what happens in the markets, the interest rate remains the same until you are finished paying off your loan
- income-driven repayment plans: if you cannot afford high repayments, the government will offer you a repayment plan that is adjusted to suit your income. This way, if you’re working in a low-income job, you won’t be forced to pay way more than you can afford
- loan forgiveness: federal student loans are forgiven after a certain amount of time. The time frame depends on your earnings, but is generally between fifteen and twenty years.
Furthermore, if you have particular financial needs, you can get a subsidized federal student loan. These loans do not begin accruing interest until after you’ve graduated, unlike unsubsidized student loans. If you qualify for an unsubsidized student loan, this is the right option for you.
The main disadvantage of federal loans is that the amount offered is capped at a much lower amount than private loans, and a strong credit record does not help in any way. However, because federal student loans are usually the best option, about $1.4 trillion of the student debt is attributable to federal loans.
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So, if federal student loans have so many benefits, why would anyone choose private loans?
Private Loans: The Good and The Bad
Private student loans are generally provided by banks, credit unions, and non-federal companies. They come with higher interest rates that are not fixed, meaning your rate will depend on the market and your credit score. You cannot get subsidized private loans and there is no debt forgiveness. You cannot get an income-driven repayment plan either.
However, if you have a good credit score, you can get a bigger student loan than you would from a federal source. You can also start paying it off immediately, rather than waiting until you have finished studying.
Mostly, private loans are useful for those who need more than what the government is offering to fund their education needs. People who have federal loans can top up through private loans, and this is where most private student loans get used.
For anyone who is eligible for a subsidized federal loan, the choice is simple. A subsidized loan ensures you start off with a smaller value to repay, with no interest accruing during your studies.
For most other college students, a federal loan is the best option. You get lower, fixed interest rates than you would with a private loan. Your loan will one day be forgiven. And payment plans are more flexible.
However, if a federal loan will not cover your entire course, a private loan can give you the top up you need.
Will Things Change?
Every student hopes that the student loan nightmare will change sometime soon. Unfortunately, no matter what happens in the 2020 elections, that is unlikely to be the case. The most liberal student loan promises from candidates will probably get blocked by the opposition.
For now, your best option is to go with a federal loan, and to find ways to earn money so as to put you in the best financial position when you graduate.
Refinancing Student Loans
Refinancing student loans is the process of swapping your current student loan for a new loan, saving you money because of low-interest rates. The question is, “when should you refinance your student loan?” It depends on your financial situation. Before making a decision, you need to analyze the pros and cons of refinancing student loans.
If your financial status is solid and you can make payments consistently, you can refinance your student loan. You would need at least a credit score in the high 600s and a stable source of income to consistently pay your loan, other debts, and expenses.
Here are the good-to-know facts about refinancing student loans:
- When should you refinance your student loan?
As soon as you’re eligible for a lower interest rate, take this opportunity to refinance your private student loan. So, you need to wait until you graduate or finish school to start refinancing your private student loan.
If you’re making payments on a repayment plan that’s income-driven or you are pushing a federal loan forgiveness program, then it’s not advisable to refinance your federal student loan.
- Can you refinance your student loan more than once?
There’s no limit refinancing a student loan. If your credit has improved and you already refinanced your loan in the past, you might want to consider refinancing your student loan again to get a lower interest rate. Refinancing doesn’t charge any application or origination fee so it won’t cost anything.
- How much can you save refinancing your student loan?
You can save thousands of dollars when you refinance your student loan. With a lower monthly payment and interest, you can free up your cash for other expenses and pay off your student loan faster. Also, a lower monthly loan payment decreases debt-to-income ratio, so you’ll get qualify for a mortgage.
Now you’re abreast of the differences between federal and private student loans. A federal loan is a subsidized loan, so it means lower repayment and fixed interest.
In addition to that, you now know when to best refinance your student loan to avail of lower monthly payments and interest rates.