Paying Off Federal Loans Vs Private Loans
Theres no definite answer when it comes to which can be paid off faster, federal student loans or private student loans. It depends on the amount of your loans, how much your payments are, your interest rate, and how much money youre making after school:
- How much is your monthly student loan payment?
- Did you choose a repayment plan where you make payments during school, or did you have a grace period after graduation?
- Is there a cosigner on the loan? Are they helping with payments?
- Are you keeping up with your payments and paying interest that accrues before it capitalizes ?
When To Consider Declining A Student Loan
When you borrow money for college tuition and related expenses, no one’s going to follow you around, counting every dollar to make sure it’s spent wisely. However, just because you do qualify for student loans, it doesn’t mean you have to take them.
Student loans are typically disbursed to your college first to cover tuition and fees for the term. If there’s any money left over after that, you’ll receive a refund check or a direct deposit for the difference.
Here are some tips to help you minimize how much you need to borrow and when to decline a student loan offer.
How To Apply For Subsidized And Unsubsidized Student Loans
To apply for a subsidized or unsubsidized federal loan, fill out the Free Application for Federal Student Aid form .
Your school uses your FAFSA form to determine how much federal student aid you qualify for, based on the cost of attendance minus expected family contribution. In a financial aid award letter, the school will tell you how much student aid you are eligible to receive.
There is no difference between applying for subsidized loans and applying for unsubsidized loans. When you fill out the FAFSA, your school will tell you what you qualify for in terms of subsidized and unsubsidized loans. Thereâs really not anything else you can do.
First-time borrowers need to sign the master promissory note and go through entrance counseling most of the time.
What do you need in order to get a subsidized loan? You need to demonstrate a financial need to qualify for a subsidized loan. There is no such requirement to qualify for unsubsidized loans.
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Differences In Subsidized Vs Unsubsidized Loans
What is the difference between subsidized and unsubsidized loans? The main difference between subsidized and unsubsidized loans is that you donât accrue interest during enrollment on subsidized loans. However, eligibility for each type of loan varies as well.
There are some key differences between federal Direct subsidized and federal Direct unsubsidized loans, including:
- Interest accrual
What is better, subsidized or unsubsidized loans? Subsidized loans are better than unsubsidized loans because you donât have to pay for any interest that accrues during your enrollment plus the 6-month grace period after finishing.
However, you can borrow more money with unsubsidized loans.
Amount Fees And Interest Rates
The maximum amount of money you can borrow in subsidized and unsubsidized student loans is determined by the U.S. government. For undergraduates, it is based on which year you are requesting the loan: freshmen, sophomore or beyond as well as whether you are a dependent student or independent student. The amount allowed for college juniors through graduate school is the same. These amounts are periodically reviewed by the U.S. Department of Education to ensure the maximum amounts allowed, the interest rates, and the fees associated with student loans are adequate to accommodate both students and lenders.
There are fees associate with processing student loan applications which are also set by the U.S. Department of Education. The fees are a percentage of the total loan amount, and that percentage can increase or decrease every year. Because the percentage changes, the fees are deducted out of each disbursement, which means the amount that is disbursed will be lower than the amount borrowed. However, you are responsible for paying back the entire amount borrowed before fees were deducted. So if you were approved for $100 disbursement and there was a $30 fee, you would only receive $70 but are responsible for paying back $100.
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Cons Of Subsidized Federal Student Loans
- The borrower has to demonstrate financial need, and a parents income and assets might disqualify a student from receiving a subsidized loan.
- Graduate and professional students are not eligible.
- Borrowing limits are lower, and the student might have to supplement with other loans.
- Unpaid loan balances dont go away in bankruptcies.
Pros And Cons Of Direct Subsidized Loans
The core benefit of Direct Subsidized Loans is how interest is handled. With the Department of Education covering your interest charges during certain periods, less interest will accrue and your total repayment cost will be lower.
Direct Subsidized Loans are a good option for undergraduates because they have low interest rates and are eligible for income-driven repayment plans. Theyre also qualifying loans for Public Service Loan Forgiveness and Teacher Loan Forgiveness, so borrowers could qualify for loan forgiveness if they work for a qualifying non-profit, government agency, or school.
However, Direct Subsidized Loans arent available to everyone. Only students with exceptional financial needs will qualify for Subsidized Loans. Even if you qualify, you will likely need other loans to pay for the full cost of your tuition because the annual and aggregate limits on Subsidized Loans are quite low.
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Interest And Repayment For Subsidized Loans
The U.S. Department of Education pays the interest on a subsidized student loan as long as youâre in school at least half-time. It continues to pay interest for the first six months after you leave school and if you get a loan deferment. Since this interest is being paid, it isnât added to your loan, which saves you money in the long run.
6-Month Grace Period
Each subsidized loan has a six-month grace period, which means you donât have to start making loan payments until six months after you:
Drop below half-time enrollment, or
Leave school entirely.
The Department of Education pays the interest on your loan during this period. This is the main reason that federally subsidized loans are less costly over time than unsubsidized loans, where the borrower is responsible for paying the interest that accrues during the six-month grace period.
Deferment vs. Forbearance
The federal government offers repayment relief if youâre experiencing short-term financial difficulties. In specific circumstances, you may qualify for a deferment or a forbearance that will temporarily stop, delay, or lower your monthly payment. Your servicer will determine your eligibility and tell you what information is needed to process the deferment or forbearance.
Because of the impact on interest and potential loan forgiveness, it might be worth exploring another repayment plan before you consider deferment or forbearance.
Federal Vs Private Student Loans
Federal student loans come with many benefits, including:
- Fixed interest rates that arent based on your credit score
- Extended deferment and forbearance
- Access to student loan forgiveness programs
- The opportunity to utilize IDR plans to make repayment manageable
IDR plans can be requested by eligible borrowers who need a lower monthly payment, and IDR payments are generally restricted to 10% to 20% of your discretionary income. Those with very low income might be eligible for $0 monthly payments.
Private student loans, on the other hand, dont adhere to the same rules as federal loans. Here are some ways private loans differ:
Although private student loans are sometimes necessary, you should explore other options for aid first. Take advantage of any scholarships and grantssince these dont need to be repaid. Then, if you need student loans, prioritize federal government student loans before exploring private loan options.
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You Should Take Out Subsidized Loans If
You should max out your subsidized student loan amounts before resorting to unsubsidized loans. But they have added benefits for those who:
- Cant Afford to Make Interest-Only Payments While in School. Interest starts to accrue on all unsubsidized loans while youre in school. So if you cant afford to make interest-only payments, subsidized loans are the solution.
- Plan to Continue Immediately to Grad School. Even though grad students dont qualify for subsidized student loans, you can defer your undergrad loans interest-free as long as youre in school.
- Plan to Enter the Public Service Loan Forgiveness Program. If you qualify for public service loan forgiveness, your loan balance can be canceled in as few as 10 years, and your subsidized student loans get additional subsidies on some of the income-driven repayment plans.
Why Is It Important To Know The Difference
The first lesson that a college student should learn is the difference between a subsidized and unsubsidized loan. This difference is important to understand because it directly affects you during college when interest is accruing on these loans and after college when these loans become due. This information will help you strategize:
how much you should borrow
how loan interest is calculated
if you should make payments while in school
if you should defer payments until after graduation
where the amount of your repayment is applied
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How Do You Get A Subsidized Loan
You apply for a subsidized or unsubsidized federal student loan the same way: Simply fill out the Free Application for Federal Student Aid .
Once the government receives your application, it forwards your information to the colleges or universities that you listed on your FAFSA.
The schools that decide to accept you will send you an acceptance letter and a financial aid package. The financial aid package will generally include information about federal and state grants, as well as your eligibility for federal subsidized and unsubsidized student loans.
Lets pause here for a moment to clarify two things that people often get confused about:
- Even though the FAFSA is a government application, your financial aid package will come from the colleges that you have applied to. You will not get an award letter from the federal government.
- You may get more or less federal financial aid depending on which school you attend.
After taking into account the free money we mentioned above, its generally best to accept all subsidized loan dollars offered to you, followed by federal unsubsidized loans and then private loans, as necessary.
How To Get An Unsubsidized Loan
To get any sort of federal loan, you must first submit the FAFSA – the Free Application for Federal Student Aid. The FAFSA is the form used by the federal government, states, colleges, and organizations to award financial aid to students. For any student looking to acquire grants, scholarships, have access to work-study programs and federal student loans, the FAFSA is a must and the first step towards college plans.
After youve completed the FAFSA, youll be able to see how many scholarships and grants youre eligible for. Take all of the federal aid youre entitled to because its free money and be sure to take advantage of any work-study thats offered to you to help pay off the loans.
When considering an unsubsidized student loan, you wont want to take on more debt than you absolutely have to, so the general guideline is to not borrow any more than you expect to make in your first year after graduating. Youll also want to apply for these federal loans first before trying to borrow private loans. Both unsubsidized and subsidized federal loans have more options for borrower repayment plans and allow for forgiveness options where private loans do not.
Although you dont have to demonstrate your financial needs as you would with a subsidized loan, you still have to meet this criterion to qualify:
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What Are Federal Direct Loans
Federal Direct Loans are education loans from the U.S. government. They are either subsidized or unsubsidized. They can also be made either to a student or to a parent .
A subsidized Stafford loan is awarded on the basis of financial need. You wont be charged any interest before you begin repayment or during authorized periods of deferment because the federal government subsidizes the interest during these periods.
Unlike a subsidized Stafford loan, an unsubsidized Stafford loan and a Grad PLUS loan is not based on financial need. Youll be charged interest from the time the loan is disbursed until it is paid in full. If you allow the interest to accumulate while you are in school or during other periods of nonpayment, it will be capitalized that is, the interest will be added to the principal amount of your loan, and then additional interest will be based on that higher principal amount.
You can receive a subsidized loan and an unsubsidized loan for the same enrollment period.
Subsidized Vs Unsubsidized Student Loans
There are some subtle differences between direct subsidized loans and their unsubsidized counterparts that you should keep in mind when borrowing money for college and making plans for repaying those debts.
The biggest difference between subsidized and unsubsidized loans is when interest is charged, and when its not.
Although unsubsidized loans to undergraduates carry the same low rate as subsidized loans, interest starts accruing on unsubsidized loans while youre still in school, as soon as the loan is disbursed.
With both subsidized and unsubsidized loans, you get the same six-month grace period after you leave school before you have to start paying your loans back. But with an unsubsidized loan, any interest that you dont pay while youre in school and during your grace period will be capitalized added to the principal amount of your loan when its time to start making monthly payments.
While the government will take care of any interest if you need a deferment on a subsidized loan, interest continues to accrue on unsubsidized loans during a deferment. Interest accrues on both types of loans if you are granted forbearance
Another feature of federal direct unsubsidized student loans to keep in mind as you chart your journey through higher education is that if youre planning on going to grad school, youll pay a higher interest rate. Remember, grad school students arent eligible for direct subsidized student loans, no matter how great their financial need.
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How A Direct Unsubsidized Loan Works
The key differences between an unsubsidized loan and a subsidized loan are the interest, loan limit and eligibility.
Unsubsidized student loans are more expensive than subsidized loans because interest starts accruing sooner on unsubsidized loans. The borrower is responsible for the interest that accrues on unsubsidized student loans during in-school and grace periods, as well as deferments and forbearances. Borrowers can choose to pay the interest as it accrues or to defer paying the interest until the student loans enter repayment. All federal student loans have a fixed interest rate.
If the borrower does not pay the interest as it accrues, the interest will capitalize and be added to the principal loan balance when the loan enters repayment. This can increase the size of the loan by as much as a tenth to a quarter. It also leads to interest compounding, since interest will be charged on the capitalized interest.
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Benefits Of Student Loans Invest In Your Future
Federal student loans are an investment in your future. You should not be afraid to take out a federal student loan because they can help fill the gap by providing essential funds to cover your educational expenses. Student loans offer financial support for students who would otherwise be unable to attend college or graduate/professional school.
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What Is An Unsubsidized Loan
Unlike subsidized loans, unsubsidized loans do not come with an interest subsidy. These loans accrue interest at all times, which the borrower must eventually pay. But, similar to subsidized loans, you dont have to start paying off unsubsidized loans until after your grace period ends. At that time, interest that has accrued will be capitalized, or added to the principal balance you originally borrowed.
Unsubsidized loans are more widely available than subsidized loans. You dont need to demonstrate financial need as a result of the information you provided on the FAFSA. You can also get them as a graduate or professional student.
Similarities Of Subsidized And Unsubsidized Student Loans
To be eligible for either a subsidized or an unsubsidized loan, a student must:
Be a U.S. citizen, national, or permanent resident
Be enrolled in school at least half-time
Not have defaulted on a previous student loan nor owe a refund to any previous aid program
Maintain satisfactory academic progress while in school
Both subsidized and unsubsidized loans have the same fixed interest rate. Congress sets this interest rate for the upcoming academic year’s loans annually each May. This interest rate is fixed for the life of the loan.
With both types of loans, you must pay an origination fee. Instead of paying this fee directly, the federal government subtracts the fee from the loan amount before giving you the funds.
You may be eligible for more money than you need to borrow. You arenât required to borrow the total amount of student loans youâre offered.
You must also complete entrance counseling and sign a Master Promissory Note before receiving initial loan funds for both types of loans. Finally, you must submit a FAFSA each year to receive Federal Direct Student Loans.
You will have several repayment options when your repayment period begins.
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