For many people, borrowing money is a key part of paying for college. While many types of debt can help students pay for school, such as credit cards, personal loans, and home equity loans, student loans are the most common type of educational debt.
If you are in the process of applying for financial aid and are considering using loans to pay for some or all of your education, it’s important to know what loan options are available to you, as well as what each option will mean for you during your time in college and after graduation.
Two distinct categories of student loans exist: federal loans and private loans. Read on to learn more about how these loans work and the differences between the two.
1. Federal Student Loans
The William D. Ford Federal Direct Loan Program provides loans to undergraduate, graduate, and professional students. The loans come directly from the federal government - the U.S. Department of Education acts as the lender, rather than a private bank or another type of financial institution. Two categories of federal loans are available: subsidized and unsubsidized. There are also Direct PLUS loans, which are available to parents of undergraduates and to graduate and professional students.
There are several notable differences between subsidized and unsubsidized federal loans.
Subsidized Loans
Subsidized federal loans are only available to undergraduate students. To qualify for a subsidized loan, you need to demonstrate financial need. The amount of the loan is based on your year in school. The maximum amount you can borrow as part of the subsidized loan program is $3,500 during your first year, $4,500 during your second year, and $5,500 in your third year and any years after that. The subsidized loan limit for your entire undergraduate career is $23,000.
When you apply for financial aid, your school will let you know how much you can borrow as part of the subsidized loan program. You can’t borrow more under the program than your total financial need. If you attended college for four years and your school determined that you were eligible to borrow the maximum subsidized loan amount for each year, you would graduate with $19,000 worth of subsidized federal student loan debt.
A key perk of the subsidized loan program is that the U.S. Department of Education will pay the interest on the loan while the borrower is still in school and is enrolled at least half-time. The government will continue to pay interest on a subsidized student loan for the first six months after a student graduates or leaves school. If you should need to defer payments on the loan at any time, the government will also pay interest.
Unsubsidized Loans
While subsidized federal loans are only available to undergraduate students, unsubsidized loans are available to all undergraduate and post-secondary students, including graduate and professional students. A student also doesn’t need to have proof of financial need to borrow under the unsubsidized loan program.
The federal government doesn’t pay interest on unsubsidized loans. A student can choose to make payments on the interest while they are still in school, or they can choose to have the accrued interest added to the principal amount after they graduate or leave school.
Unsubsidized loans have higher limits than subsidized loans. For graduate and professional students, the yearly limit is $20,500. For undergraduate students, the maximum amount of unsubsidized loans they can take out is based on their year in school, whether they have subsidized loans or not, and whether they are someone’s dependent or not.
Over the course of their undergraduate career, a dependent student can take out up to $31,000 through the Federal Student Loan Program, with a maximum of $23,000 being in the form of subsidized loans. The remaining amount can be unsubsidized loans. If a student doesn’t qualify for subsidized loans, they can borrow up to the maximum annual and lifetime limit as unsubsidized loans.
An independent undergraduate student can take out up to $57,500 total over the course of their college career, with no more than $23,000 coming from subsidized loans. Students who end up pursuing graduate or professional degrees can use up to $138,500 over the course of their entire time in school, with no more than $65,000 being in the form of subsidized loans.
Applying for Federal Loans
If you’re interested in applying for a federal loan, you need to complete the Free Application for Federal Student Aid (FAFSA). The FAFSA asks you questions about your income and savings and about your parents’ income and savings if you’re a dependent student.
Your school uses the information you provide on the FAFSA to determine how much aid you qualify for and the types of aid you can receive. It will then send you an award letter to let you know if you are eligible for subsidized or unsubsidized loans (or both) and the amount you can borrow.
You do not need to undergo a credit check to get a federal student loan. Interest rates on the loans are fixed, so they stay the same for the duration of the loan. They are also usually lower than the rates on private loans.
2. Private Student Loans
For many students, federal loans alone may not cover the full cost of education, especially at private or out-of-state institutions. Private loans can help bridge this gap. These are issued by a credit union, bank, or other type of financial institution. While eligibility for federal loans is based on the information provided on the FAFSA, eligibility for private loans is based on your credit history. A lender will run your credit before deciding to approve you for a private student loan. You might need to have a cosigner, such as a parent, if you have a limited credit history or no history.
When you take out a private student loan, you are responsible for paying the interest on the loan at all times, although some private student loan programs will let you defer interest and payments until after you graduate or leave school. The interest rate might also change over time on a private loan.
It pays to shop around if you are considering taking out a private loan to pay for school. Different lenders will offer different interest rates, terms, and repayment options. For example, some lenders might allow you to make interest-only payments on your loan during the first 12 months after you leave school.
Using Your Home Equity for Education Financing
If you or your parents are homeowners, another option for financing education is to use the equity you’ve built up in your home. A home equity loan or home equity line of credit (HELOC) can offer you flexible terms and competitive rates, making it an attractive option for covering tuition and other educational expenses.
With a home equity loan, you can borrow a lump sum based on the value of your home, while a HELOC allows you to borrow as needed over time. Both options provide a way to finance education with potentially lower rates than private student loans, especially if you have significant equity in your home.
Before choosing a home equity product, it’s important to weigh the pros and cons. While these loans may offer lower interest rates, they use your home as collateral, which means there’s a risk of losing your home if you can’t repay the loan.
PSECU Can Help You Pay for School
We believe a college degree can help ensure a bright financial future. That’s why we want to help make college affordable by partnering with Sallie Mae® to make several student loan options available to help put the cost of college within reach. The Smart Option Student Loan for PSECU by Sallie Mae® offers competitive rates and flexible repayment options.
We also believe that you shouldn’t have to pay to use your own money. Our savings and checking accounts have few, if any, fees – something college students can appreciate. We also provide tools to help make informed decisions about things like borrowing. Using our student loan calculator can help you determine how much you can borrow for school and pay back after graduation.
Discover more ways to save and pay for college by visiting our Resource Center.
