by Emily Starbuck Crone
As college costs rise, more students are taking out loans to help pay for school. Of those who graduated from college in 2013, 69% had student loans, with an average debt amount of $28,400 per student, according to the Institute for College Access & Success. At one in five schools, that amount was at least 10% higher.
Grappling with significant debt as you enter the real world poses financial challenges, especially if you have trouble finding a well-paying job after graduation. This makes it crucial to borrow only what you need and to choose the best loans for your situation. The student loan process may seem overwhelming at first, so use this guide to better understand how it works and to become familiar with the types of loans available.
The student loan application process
Start by completing the Free Application for Federal Student Aid (FAFSA), available online at fafsa.ed.gov. You must complete it each year to be eligible for federal loans, grants and scholarships.
The government sends a copy of your FAFSA to the schools you’re applying to. The school’s financial aid office determines your aid package and will send you a financial aid award letter.
Jodi Okun, owner of College Financial Aid Advisors, says this letter has two sections: one for gift aid, containing free grants and scholarships (which students shouldn’t turn down), and one for loans.
You may be offered one or more federal loans, but you don’t have to take on all of them if you don’t need to. “You will be allowed to accept or decline any of the aid on the award letter,” says Vicki Hendrickson, director of financial services at the University of Tulsa.
To borrow responsibly, “look to the lowest-cost options first and maximize grants, scholarships, family contributions, state aid or institutional aid,” Hendrickson says.
Consider accepting federal work study or tuition payment plans, if available. Next, go for any federal loans offered. If those options combined won’t cover all costs, then pursue credit-based loans. We’ll go into more detail on loan types below.
If you were offered federal loans and want to accept them, you’ll need to activate them online, Okun says. Then you’ll sign a master promissory note detailing the loans’ terms and complete a brief online loan counseling session. The government then sends the money to your college, which, in turn, sends it along to you. However, if you have a credit from a loan on your school bill, meaning you accepted more loans than were needed for tuition, you can get a refund and use it for living expenses, Okun says.
Too much jargon? Check out NerdScholar’s Finance Glossary for Students.
Types of federal loans
Federal loans have fixed interest rates that are typically lower than private loans. All of them, except for PLUS loans, have limits on the amount you can borrow each year.
- Federal Perkins Loans: Subsidized loans with low interest rates intended only for students with significant financial need. Not all schools offer them. Interest isn’t charged while you’re in school at least half-time, and there’s a grace period of nine months after you leave school before you’re required to start paying them off.
- Direct Subsidized Loans (or Subsidized Stafford Loans): For students with demonstrated financial need. Interest isn’t charged while you’re in school or during deferment periods, and payments aren’t required until after graduation.
- Direct Unsubsidized Loans (or Unsubsidized Stafford Loans): Not based on financial need; your school decides how much you can borrow by factoring in any other financial aid and attendance costs. Interest is charged and added to the principal, or the disbursed amount of your loan, at all times — even during school and deferment periods. You can defer interest payments until graduation.
- Direct PLUS Loans: Credit-based, unsubsidized loans for graduate or professional students (called Grad PLUS loans) and parents of dependent undergraduates (called Parent PLUS loans) who need more money than they can get through federal loans. Interest rates are higher, and there is no borrowing limit
Selecting private loans
When federal aid and family contributions combined won’t cover everything, a small percentage of students take out private loans to fill in the gaps. Experts recommend using loan calculators (like the ones on studentloans.gov) to determine exactly how much you need and what your repayment plan will look like.
While students can choose any private lender, Hendrickson says, some schools provide a preferred lenders list. She adds that most student borrowers need to apply with a cosigner because they lack credit. This actually benefits you. “A qualified cosigner may speed up the application process and give the borrower a better chance of approval and help lower the interest rate,” she says.
When comparing private loans, students should consider many factors, including fees, interest rates and terms, says Andrew Hopkins, vice president of Discover Student Loans. Some lenders charge origination fees, and interest rates for private loans are not fixed as they are for federal loans, he adds.
Hopkins also recommends looking at the number and amount of monthly payments because they will affect the total cost of your loan. Also, find out if you’re allowed to repay loans while in school; doing so can reduce the cost of the loan.
Hendrickson says borrowers should also compare requirements for eligibility, because some private loans require you attend school a certain amount of hours or make certain grades. She also recommends looking for interest rate discounts and learning about repayment options.
Student loans may be complicated, but learning how the process works and which loans are ideal for you is a small price to pay for an invaluable college experience.
This article was written by NerdWallet and was originally published on USA Today.
Emily Starbuck Crone is a staff writer at NerdWallet, a personal finance website.