Student loan borrowing is a reality for many families. In fact, loans can be a helpful way to meet college expenses when grants/scholarships or savings aren’t enough to cover the bill. As a financial aid administrator, I’ve helped families pay for college while making smart decisions about student loan borrowing.
Here are the most commonly asked questions from families and my tips to help reduce college costs.
1. Wait, why are there loans in our financial aid package?
Seems strange, I get it. Federal direct student loans (formerly known as Stafford) are commonly seen in financial aid awards. They are considered financial aid due to their favorable interest rates and repayment terms. And there is no credit requirement. Eligibility is based on the student’s grade level and enrollment status — and in some cases, financial need. (More on that later!)
The college may also offer its own loans or loans from the state. These often come with generous rates and terms. But limited pools of funds can make them scarce.
Although less common, colleges may list a parent loan on the award letter — essentially suggesting one way the family could meet remaining expenses. Unlike with federal student loans, there is no eligibility guarantee and parents must go through the credit approval process.
Don’t just look at the total amount of the financial aid package when comparing award letters.
Tip
Because loans are commonly found in the aid package, and there can be various types of loans from different sources, don’t just look at the total amount of the financial aid package when comparing award letters. Calculate the actual cost you’ll pay for each college by subtracting the grants and scholarships awarded by each school from the total cost. Then compare loans.
2. What is the difference between Direct Subsidized and Direct Unsubsidized Loans?
Direct Subsidized and Direct Unsubsidized student loans have a lot in common. They have the same interest rate — set by Congress each year — and it’s fixed for life. There is no credit requirement, but they do have maximum annual and lifetime borrowing limits. And you have multiple repayment options to select from after your student leaves college. The main difference between the two is how interest accrues.
- Eligibility for Direct Subsidized Loans is determined by financial need. The student makes no payments while enrolled, and interest does not accrue until they leave school.
- Direct Unsubsidized Loans are non-need based, and like their subsidized counterparts, no payments are required while the student is enrolled, but interest does accrue.
Tip
Even though payments are not required while the student is enrolled, it’s wise to make interest-only payments to lower total interest in the long run.
3. Do we have to take the loans?
The decision to borrow student loans ultimately rests with the student. They can accept or decline any type of loan offered in the package. Or they can take a portion of the loan — for example, if your family also has money set aside in a college savings account or the student is awarded a local scholarship.
Not all loans are created equal.
Tip
Not all loans are created equal. If you need to borrow, obviously take the best loan first. Federal student loans usually win out here. Not only because of their fixed, favorable interest rates, but because there are about six repayment options to choose from. And they’re flexible — you can change your plan at least once per year. Federal loans can have other perks too; for the better part of the pandemic, borrowers were allowed to pause payment.
4. What if we need to borrow more than what’s offered in the aid package?
Parents can apply for a Direct PLUS Loan even if it’s not offered or mentioned in the aid package. The FAFSA is required, and parents need to be approved based on credit.
In addition to the loans already offered in the award package, students and/or parents may be able to borrow private or alternative education loans to help cover remaining expenses.
Tip
Consider savings and payment plan options first since loans can be costly in the long run with interest.
Only the student will be financially responsible for repaying their loans.
5. What is the right amount to borrow?
This is an important question to ask because only the student will be financially responsible for repaying their loans. How loans are managed will impact a student’s credit and overall finances well past college.
A good rule of thumb: Keep the total borrowing amount equal to or less than one year of the student’s potential entry-level salary.
Earlier, I mentioned federal direct student loans and annual loan limits. The maximum amount a dependent student can borrow is $31,000 — for most graduates, that’s an acceptable amount of debt to manage.
Borrowing can have benefits. It can give students a sense of responsibility to make the most of their college experience and protect their investment. And good repayment habits can help build credit.
One of the best ways to reduce overall borrowing is to save. And that’s true for both parents and students. The more money each one sets aside before college, the more options there will be to pay the bill and cover living and personal expenses.
To promote savvy spending and borrowing habits, pay attention and stay organized.
Tip
An important rule of financial management is to know what you’re spending and what you’re spending it on. To promote savvy spending and borrowing habits, pay attention and stay organized. This will help curb overspending.
A great tracking tool for federal student loans is right in your Federal Student Aid account. There you will find information about current loans, and you can use repayment estimators to see what your monthly payments could look like down the road.
