After completing this section, you should be able to:
All college students are eligible to apply for a loan regardless of their financial situation or credit rating. Federal student loans do not require a co-signer or a credit check. Most students do not have a credit history when they begin college, and the federal government is aware of this. However, private loans will generally require a co-signer as well as a credit check. The co-signer will assume responsibility for paying off the loan if the student cannot make the payments.
The first step in applying for student loans is to fill out the FAFSA (Free Application for Student Aid). FAFSA determines financial need and what type of loan the student is qualified to obtain. For students who are still dependents on their parent’s taxes, the parents also fill out the FAFSA, as their wealth and income impacts what the dependent student is eligible for. Students who cannot demonstrate financial need will also be helped by applying with FAFSA, as it will help guide them to the type of loan most appropriate. The FAFSA must be submitted each year.
The FAFSA deadline is the spring of the student’s next academic year. The deadline is often in March. Do not allow this deadline to pass.
As soon as an offer letter from the college is received, the student should start the application process. The college will determine the loan amount needed. Also, there are limits on the amount a student can borrow. There are both yearly limits and aggregate limits. See the table later in this section that outlines the loan limits per school year and in the aggregate.
If the student receives a direct subsidized loan, there is a limit on the eligibility period. The time limit on eligibility depends on the college program into which the student enrolls. The school publishes how long a program is expected to take. The eligibility period is 150% of that published time. For example, if a student is enrolled in a 4-year program, such as a bachelor’s degree program, their eligibility period is 6 years, as 1.50(4) = 6. Therefore, the student may receive direct subsidized loans for a period of 6 years.
Once a tuition statement is received, and all the non-loan awards are analyzed that are applicable to the costs of college (such as scholarships and grants), there still may be quite of bit of an expense to attend college. This difference between what college will cost (including tuition, room and board, books, computers) and the non-loan awards received is the college funding gap.
Ishraq receives her award and tuition letter from the college she wants to attend. Her tuition, fees, books, and room and board all come to $24,845 for the year. Her non-loan awards include an instant scholarship from the school for $7,500, a scholarship she earned for enrolling in a STEM program for $3,750, and a $1,000 scholarship from her church. What is Ishraq’s college funding gap?
Her awards total to $12,250. Her cost to attend is $24,845. Her college funding gap is then $ 24,845 − $ 12,250 = $ 12,595 $ 24,845 − $ 12,250 = $ 12,595 . She will need to find $12,595 in funding.
Yuan-Teng receives his award and tuition letter from the college he wants to attend. His tuition, fees, books, and room and board all come to $34,845 for the year. His non-loan awards include an instant scholarship from the school for $17,500, three scholarships he earned from sources he found online, which total $5,600, and a $2,000 scholarship from his employer. What is Yuan-Teng’s college funding gap?
There are several loan types, which basically break down into four broad categories: subsidized loans, unsubsidized loans, PLUS loans, and private loans. These loans are meant to fill the college funding gap.
Federal subsidized loans are backed by the U.S. Department of Education. These loans are intended for undergraduate students who can demonstrate financial need. Subsidized federal loans, including Stafford loans, defer payments until the student has graduated. During the deferment, the government pays the interest while the student is enrolled at least half-time. These loans are generally made directly to students. However, there are restrictions on how the money can be used. It can only be used for tuition, room and board, computers, books, fees, and college-related expenses. Interest rates are not based on the financial markets but determined by Congress. Federal loans are backed by the Department of Education.
Federal unsubsidized loans , including unsubsidized Stafford loans, are available for undergraduate and graduate students who cannot demonstrate financial need. If the student meets the program requirements, they are automatically approved. The student is not required to pay these loans during their time in college (enrolled at least half-time). However, the interest rate is generally higher and there is no deferment period, as with subsidized loans. Interest begins accruing as soon as the money is disbursed.
The immediate accrual of interest means the balance of the loan grows as the student attends school. A loan that was for $10,000 can grow past $13,000 over five years of college. Some advisors tell students to pay the interest portion of the loan while it is deferred to prevent this growth of debt.
Parent Loans for Undergraduate Students (PLUS) are federal loans made directly to parents. They are available even if parents are not deemed financially needy. A credit check is performed and approval is not automatic. The limit to what parents can borrow from a PLUS loan each year is still the college funding gap, but the aggregate of the PLUS loans does not have a limit. This means the PLUS loan can cover whatever is left in the funding gap once all other aid and loans are applied. Payments do not begin until the student is out of school, but interest begins to accrue the moment funds are disbursed. Because the parents take out the loan, the parents are responsible for paying back the loan.
Private student loans are backed by a bank or credit institution and require a credit check, and interest rates are variable. As private loans are not subsidized by the government, no one pays the interest but the borrower. The student does not have to start repaying the loan until after graduation, but interest starts to accrue immediately. This loan has fewer repayment options, more fees and penalties, and the loan cannot be discharged through bankruptcy. Many students need a co-signer to acquire a private loan. Like PLUS loans, private student loans can cover whatever is left in the funding gap once all other aid and loans are applied
Student loans, in general, have a term of 10 years, that is, the loans are paid back over 10 years. This can vary, but 10 years is the standard.
Private loans can fall into one of two categories: school-channel loans and direct to consumer loans. School-channel loans are disbursed directly to the school. The school verifies the loan does not exceed the cost to attend school. Direct–to-consumer loans do not have the verification process. Those proceeds are sent directly to the borrower. They are processed more quickly, but often have higher interest rates.
As mentioned earlier, there are limits to how much a student can borrow, per year and in total. The following table shows a general breakdown of the amounts the federal government and private lenders will lend. Amounts are based on level of need and whether the student is a dependent or an independent student. Independent students include those who are at least 24 years old, married, a professional, a graduate student, a veteran, a member of the armed forces, an emancipated minor, or an orphan. The amounts shown are as of this writing in 2022.
| Year | Dependent Students Maximum Amounts | Independent Students Maximum Amounts |
|---|---|---|
| First-Year Undergraduate | $5,500 but no more than $3,500 may be in subsidized loans | $9,500 but no more than $3,500 may be in subsidized loans |
| Second-Year Undergraduate | $6,500 but no more than $4,500 may be subsidized loans | $10,500 but no more than $4,500 in subsidized loans |
| Third Year and Additional Years | $7,500 but no more than $5,500 may be in subsidized loans | $12,500 but no more than $5,500 may be in subsidized loans |
| Graduate and Professional | Not applicable | $20,500 in unsubsidized loans |
| Limits | $31,000 but no more than $23,000 in subsidized loans | $57,500 for undergraduates but no more than $23,000 in subsidized. $138,500 for graduate or professional but no more than $65,500 may be subsidized loans. |
Efraim is a dependent undergraduate student enrolled in a biology program. He’s about to attend for the fifth year. In year 1 he took out $5,000 in federal subsidized and unsubsidized loans, in year 2 he took out $6,400 in federal subsidized and unsubsidized loans, in years 3 and 4, he took out the maximum federal subsidized and unsubsidized loans amounts. He needs federal subsidized and unsubsidized loans for his fifth year of school. How much can he obtain in federal subsidized and unsubsidized student loans?
The sum of his previous loans is $ 5,000 + $ 6,400 + $ 7,500 + $ 7,500 = $ 26,400 $ 5,000 + $ 6,400 + $ 7,500 + $ 7,500 = $ 26,400 . The limit for federal subsidized and unsubsidized loans is $31,000, so in year 5 he can get student loans in the amount of $ 31,000 − $ 26,400 = $ 4,600 $ 31,000 − $ 26,400 = $ 4,600 .
Tiana in an independent college student entering the sixth and final year of her engineering program. In the previous years, she took out student loans of $5,500, $8,470, $10,000, $7,890, and $11,900. She needs a loan to finish her final year. How much in federal subsidized and unsubsidized student loans can she obtain?
Putting this all together, we have a way to determine the student loans needed for a student to attend college.
At each step, if the student and family can cover some or all of the gap, they can do so without taking out a loan.
Olivia receives her award and tuition letter from the college she wants to attend. Her tuition, fees, books, and room and board all come to $44,845 for her second year. Her non-loan awards include an instant scholarship from the school for $13,500, a scholarship she earned for enrolling in an engineering program for $5,750, and a $2,000 scholarship from her parent’s workplace. For her first year, what is Olivia’s college funding gap? How much can Olivia borrow in federal subsidized and unsubsidized student loans? Once Olivia takes out her maximum subsidized and unsubsidized federal student loans, how much will have to be paid for using PLUS and private student loans?
Her awards total to $21,250. Her cost to attend is $44,845. Her college funding gap is then $ 44,845 − $ 21,250 = $ 23,595 $ 44,845 − $ 21,250 = $ 23,595 . The maximum in federal student loans that Olivia can borrow is $6,500 in year 2. The remaining funding gap is $ 23,595 − $ 6,500 = $ 17,095 $ 23,595 − $ 6,500 = $ 17,095 . Private student loans, PLUS loans, or other sources must be used to cover this gap.
Makenzy receives her award and tuition letter from the college she wants to attend. Her tuition, fees, books, and room and board all come to $39,200 for her third year. Her non-loan awards include an instant scholarship from the school for $19,500, three scholarships she earned from sources she found online which total $3,850, and a $5,000 scholarship from her employer. What is Makenzy’s college funding gap? How much can Makenzy borrow in federal subsidized and unsubsidized student loans? Once she takes out her maximum subsidized and unsubsidized federal student loans, how much will Makenzy and her family have to pay using PLUS and private student loans?
Student loans are first and foremost loans. Students will pay them back and will pay interest. In the fall of 2022, the federal student loan interest rate was 4.99%. Private student loans rates ranged between 3.22% and 13.95%. Finding the lowest interest rate you can helps with the payments, and especially helps if the loan is not federally subsidized. Remember, if the loan is not federally subsidized, the student is on the hook for the interest that is accumulating with the loan.
The interest on student loans begins as soon as the loan is disbursed (paid to the borrower). When the loan is federally subsidized, the government pays that interest for the student. This means the loan for a subsidized loan of $3,000 is still a loan for $3,000 when the student graduates. However, if the loan is not federally subsidized, the student is responsible for the interest that accrues on the loan. The $3,000 loan from year 1 of college is now a loan for more due to that added interest. The interest on that loan grew while the student was in college. The formula for growth of the loan’s balance is the same as compound interest formula from Compound Interest, A = P ( 1 + r n ) n t A = P ( 1 + r n ) n t .
Denise takes out unsubsidized student loan, in August, in her first year of college for $2,000. She manages an interest rate of 8%. She graduates after her fifth year of college, in May. She does not pay the interest on the loan during her time in college. What is the balance of her first year loan in May of her graduation year?
The principal of the loan is $2,000. Her interest rate is 8%. Since student loans are typically paid monthly, there are 12 periods per year. Since the time she has had the loan is not in years, we will use the number of months for the value of nt nt in the formula. She has had the loan for 4 years and 9 months, meaning 57 period have passed. Substituting those values into the formula and calculating, we find her balance in May of her graduating year is A = P ( 1 + r n ) n t = $ 2,000 ( 1 + 0.08 12 ) 57 = $ 2,000 ( 1.0 6 ¯ ) 57 = $ 2,920.89 A = P ( 1 + r n ) n t = $ 2,000 ( 1 + 0.08 12 ) 57 = $ 2,000 ( 1.0 6 ¯ ) 57 = $ 2,920.89 .
Priya takes out unsubsidized student loan, in August, in her first year of college for $2,000. She manages an interest rate of 7%. She graduates after her sixth year of college, in May. She does not pay the interest on the loan during her time in college. What is the balance of her first year loan in May of her graduation year?
There are various repayment plans available. The one most likely to apply to a student loan is the standard repayment plan, which is available to everyone. Borrowers pay a fixed amount monthly so the loan is paid in full within 10 years. Consolidated loans, discussed later in this section, also qualify for the standard repayment plan, and may allow the payoff period to range from 10 to 30 years. Direct subsidized and unsubsidized loans, PLUS loans, and federal Stafford loans are eligible.
Since these are loans, they are paid back with interest. As with most installment loans, their payments are due monthly. The formula for paying back these loans is the same as the formula used for paying loans in The Basics of Loans:
p m t = P × ( r / n ) × ( 1 + r / n ) n × t ( 1 + r / n ) n × t − 1 p m t = P × ( r / n ) × ( 1 + r / n ) n × t ( 1 + r / n ) n × t − 1 .
Using that formula, we can calculate how much the payment is for a student loan. Remember that all loan payments are rounded up to the next penny.
Find the payment for the following student loans using the standard repayment plan:
p m t = P × ( r / n ) × ( 1 + r / n ) n × t ( 1 + r / n ) n × t − 1 = $ 3,500 × ( 0.0499 / 12 ) × ( 1 + 0.0499 / 12 ) 12 × 10 ( 1 + 0.0499 / 12 ) 12 × 10 − 1 = $ 3,500 × ( 0.004158 3 ¯ ) × ( 1.004158 3 ¯ ) 120 ( 1.004158 3 ¯ ) 120 − 1 = $ 23.9469911276 0.645370131872 = $ 37.11 p m t = P × ( r / n ) × ( 1 + r / n ) n × t ( 1 + r / n ) n × t − 1 = $ 3,500 × ( 0.0499 / 12 ) × ( 1 + 0.0499 / 12 ) 12 × 10 ( 1 + 0.0499 / 12 ) 12 × 10 − 1 = $ 3,500 × ( 0.004158 3 ¯ ) × ( 1.004158 3 ¯ ) 120 ( 1.004158 3 ¯ ) 120 − 1 = $ 23.9469911276 0.645370131872 = $ 37.11
p m t = P × ( r / n ) × ( 1 + r / n ) n × t ( 1 + r / n ) n × t − 1 = $ 6,200 × ( 0.0675 / 12 ) × ( 1 + 0.0675 / 12 ) 12 × 10 ( 1 + 0.0675 / 12 ) 12 × 10 − 1 = $ 6,200 × ( 0.005625 ) × ( 1.005625 ) 120 ( 1.005625 ) 120 − 1 = 68.3662233426 0.960321816275 = $ 71.20 p m t = P × ( r / n ) × ( 1 + r / n ) n × t ( 1 + r / n ) n × t − 1 = $ 6,200 × ( 0.0675 / 12 ) × ( 1 + 0.0675 / 12 ) 12 × 10 ( 1 + 0.0675 / 12 ) 12 × 10 − 1 = $ 6,200 × ( 0.005625 ) × ( 1.005625 ) 120 ( 1.005625 ) 120 − 1 = 68.3662233426 0.960321816275 = $ 71.20
