Education loans allow the borrower to use their loan funds to pay for any expenses related to their tuition and the official cost of attendance. The official cost of attendance, or student budget, includes tuition and fees, room and board (for students enrolled at least half time), required books and supplies, as well as transportation and personal expenses. However, private student loans may limit the loan to only institutional charges which includes just the tuition and fees. This scenario is more likely is the applicant has marginal credit.
An education loan may also have annual and aggregate loan limits. The annual loan limit refers to the maximum amount of money you are able to borrow each year. The aggregate loan limit is the maximum amount of money you are able to borrow in total. The aggregate limit can apply to either all educational debt or just the individual loan program.
In order to qualify for an educational loan, most private and all federal education loans need to be school-certified, meaning that the college is required to verify that the student is enrolled and determines the maximum amount the student is eligible to borrow. Private student loan programs may reduce the eligible amount based on past credit criteria.
How Does The Repayment Process Work?
Education loans typically have three time periods: the in-school period, the grace period and the repayment period. Most education loans do not require the student to begin making payments while they are still in school. Some loans provide for either a 6 or 9-month grace period after graduation during which the applicant is not required to begin making payments. Following the grace period, the repayment period begins and the borrower must start making monthly payments of principal and interest or they will be considered delinquent, meaning they have failed to make a payment on time, or in default, meaning they have failed to make a payment for 120 days on a private student loan or 270 days on a federal education loan.
What is the Loan Term on an Education Loan?
The loan term refers to the number of years the loan will be in repayment. The length of the loan term affects the size of the required monthly payments. A longer loan term reduces the size of the monthly payments, but will increase the total interest paid over the loan term. For example, increasing the loan term on a federal loan from 10 years to 20 years will reduce the monthly payment by approximately a third (34%), but more than doubles the total interest paid over the loan term (a factor of 2.18 increase in the total interest). For these reasons, if able, it is best to continue with the shortest loan term plan.
- Most private student loans offer repayment terms of 15 to 30 years (20 years is the most common). Private loans prefer to use longer repayment terms in order to reduce the monthly payments, despite the higher interest rates and fees on the private student loan. This can make the loans seem more affordable in the present, even though the total cost is greater than a shorter loan term.
For example, if we compare a $40,000 education loan using a federal and private lender, it is essential to ask not just about the monthly payments, but also about the total cost of the loan. A federal education loan with a ten-year loan term and a 6.8% interest rate, requires monthly payments of about $460. A private lender may choose to have a twenty-year loan term and a 10% interest rate, requires monthly payments of about monthly payments of $386. This way the private education loan appears cheaper. However, the total payments on the private student loan are $92,640 (of which $52,640 is interest), which is notably higher than the total payments of $55,200 (of which $15,200 is interest). Be sure to always inquire about both the monthly payments and the total cost of the loan.
What Is the Cost of the Loan?
- Besides the loan term, origination fees, default fees and interest rates have the greatest impact on the total cost of the loan. The interest rate is a fee charged monthly based on a percentage of the outstanding balance owed on the loan. The origination and default fees are one-time fees charged up-front based on the initial balance of the loan. These fees are not collected in advance
- Some lenders will offer discounts on the interest rates and fees. These discounts are generally small and may have extensive requirements. The most common discount is a 0.25% interest rate reduction for having your monthly payments automatically withdrawn from your bank account.
- You should always focus on the lowest cost loan. This is typically the loan with the lowest no-fee equivalent interest rate. This could be affected by the deductibility of interest on an education loan. Up to $2,500 in interest paid on a qualified education loan could be deducted as an above the line exclusion from your income of federal income tax returns. This means that you are eligible to take the deduction, which will reduce your adjusted gross income.
Who is Responsible for Repaying the Loan?
Under an education loan, usually either the student or the parent is responsible for repaying the loan. Private student loans are typically student loans, but since students may not have good enough credit to qualify for the loan, a cosigner could be required. A cosigner is equally responsible for repaying the loan, if the applicant is unable. The repayment history, which includes any late payments, on a cosigned loan will be reported on the credit history of both the student and cosigner and will affect both of their credit scores.