College can be an exciting time for your child – but it can also be very expensive. Student loans are rising, and the cost of college has never been higher. But just how do student loans work, and what do you, as a parent, need to know about them?
If you’re a parent who has or will support your child through college and want to help them navigate the world of student loans, this guide is for you. Here, you will find essential information to help your child make educated financial decisions while navigating financial aid, scholarships, and college costs.
Types of Student Loans
There are two types of loans for new college students: federal and private. Once your child graduates, they can also access refinance loans. But, for parents who want to help their kids find the right loans to pay for their college education, here’s a breakdown of what federal and private loans are and how to make the right choice for you and your family.
Federal Student Loans
Federal student loans are the most common type of loans that students use to finance their higher education. Since the U.S. Department of Education is the lender for federal loans, they don’t require a co-signer or a good credit score, and most US students with a high school diploma are eligible to receive them.
It’s important for parents and students to become familiar with the different types of federal loans that are available before applying. Below, you will find the three main types of federal student loans with information on their varying benefits and terms.
Direct Federal Loans
Direct federal student loans offer borrowers the widest range of repayment options and protections, including:
- Income-driven repayment plans
- Loan terms that range from 10 to 30 years
- Maximum loan amount varies based on whether students are dependent or independent of parents
- Six-month grace period after graduation
- Possibility of Public Service Loan Forgiveness
Direct federal loans can be divided into two categories: subsidized and unsubsidized. According to the US Department of Education’s Federal Student Aid website, both offer a fixed interest rate of 4.99%. However, there are key differences that parents and students should be aware of before applying:
Subsidized Direct Federal Loans
Eligibility for subsidized loans is based on financial need. These loans don’t accrue interest while your child is still in school or during deferment periods, which results in lower repayment amounts over time.
It’s important to remember that subsidized federal loan eligibility is limited to 150% of (or 1.5 times) the length of your child’s academic program. For example, if your student is enrolled in a two-year associate degree, they have three years of eligibility. For four-year bachelor’s degrees, students can receive unsubsidized loans for a maximum of six years.
If students are still enrolled in school once that period ends, they can continue to take out federal loans, but these will be unsubsidized, and any existing subsidized loans will begin to accrue interest.
Unsubsidized Direct Federal Loans
Any student can take out unsubsidized direct federal loans, regardless of income level or financial need. They begin to accrue interest immediately after the funds are disbursed, including any grace periods. Unlike subsidized loans, there is no time limit on using unsubsidized loans, and students can take as long as they need to graduate.
Although Perkins loans are no longer available, they’re worth mentioning since many parents may be familiar with them from the time they were in school. These low-interest loans were available to undergraduate and graduate students with exceptional financial needs. However, Perkins loans ended in 2017.
Federal direct PLUS loans are available to graduate students and parents of dependent undergraduate students. If your child is college-bound and you’d like to take out a loan for them, PLUS loans can be an option. Loan facts to keep in mind include:
- Credit check for borrowers
- In case of adverse credit history, you may need a co-signer
- Maximum loan amount is limited to the cost of attendance minus any financial aid
- Possibility of deferred payments while the student is in school and up to six months after graduation
- According to the Federal Student Aid website, interest rate for PLUS loans is fixed at 7.54%
Private Student Loans
Many parents and their students consider applying for a private student loan when federal loans are not an option. With a bank or credit union as the lender, these funds can be used to cover any costs related to attending college.
When applying for a private student loan, it’s important to keep the following information in mind:
- Private loans require a credit check, but there are lenders that specialize in student loans for borrowers with lower credit scores
- Private loans vary greatly in interest rates and terms
- Refinancing options may be limited with private loans
- If the student is taking out the loan, they’ll likely need a co-signer
- There are private student loans for international students, although these often require a US-based co-signer
- Many nonprofit organizations offer student loans
Because private loans vary from one institution to another and depend on the borrower’s credit or income, it’s important to consider all terms and conditions of the loan before accepting it.
How Parents Can Help Kids with Student Loans
Given today’s economic environment, you may be wondering how you can help your kids tackle their college debt. No matter what your personal financial situation may be, the following tips can come in handy to ease your child’s student loan burden:
- Pitch in with monthly repayments whenever possible
- Instead of birthday or holiday gifts, make a full or partial payment to your child’s student loan
- Ask your child if you can help with other expenses; such as groceries, medical costs, or entertainment
- Sign up for rewards programs like Upromise, which can help pay off your child’s student debt
- Consider co-signing your child’s loan, so they access a lower interest rate
How to Teach Your Kids to Use Student Loans Wisely
Student loans can be a wise investment. When used responsibly, they can help students afford the cost of attending college and acquire an education that’ll increase their earning potential – but the key here is the word “potential.”
When discussing student loans, your child’s major needs to be part of the conversation. Many financial experts urge students to look into the average expected income to determine what is an affordable monthly loan payment. Keeping these numbers in mind will help you and your student understand what type of loan terms are most appropriate.
It’s also important to have an honest conversation about the responsibilities of taking out a loan and what that means for your child’s financial future. Many young college students don’t fully understand how a monthly loan payment will affect their cash flow. Others may feel tempted to splurge their student loan money on non-school related expenses, only to pay the price years later.
When you talk to your child about the reality of a student loan, you can also brainstorm ways that they can start setting money aside to pay loans back when the time comes. Some of these ideas can include:
- Refinancing the loan after graduation
- Helping your child find side gigs to supplement their income
- Understanding the value of the degree earned to negotiate salary increases
- Acquiring work experience while still in school to build up your child’s resume and access higher-paying jobs
- Using the “snowball method” to focusing on the loans that have the highest interest rates
The Latest on Student Loan Forgiveness and Moratorium
With all the recent news about student loans, there is a lot of confusion on debt forgiveness and what a moratorium really means. To help you understand what’s going on and what may happen next, here’s a recap of President Biden’s student loan relief program, as published by the White House:
- The objective of this plan is to achieve targeted debt relief to offset growing college costs and the financial difficulties caused by the pandemic.
- The Department of Education will provide up to $20,000 in debt cancellation to Pell Grant recipients with loans held by the Department of Education, and up to $10,000 in debt cancellation to non-Pell Grant recipients whose individual income is less than $125,000 or $250,000 for married couples.
- The pause on federal student loan repayment will be extended through December 31, 2022.
In addition to the above, several proposed actions could help further reduce the cost of college and the burden of student debt:
- The proposed new income-driven repayment plan would protect low-income borrowers from making any payments while capping monthly payments for undergraduate loans at 5% of a borrower’s discretionary income.
- Proposed changes to the Public Service Loan Forgiveness (PSLF) would make borrowers who have worked at a nonprofit, in the military, or in federal, state, tribal, or local government, eligible to receive credit toward loan forgiveness.
- To protect future students and taxpayers, President Biden has also expressed his intention to double the maximum Pell Grant, make community college free, and put measures in place to ensure that degrees received offer value.
- Reform loan forgiveness to allow community college borrowers to be debt-free within 10 years.
Off to College!
As your child prepares for college, your job as a parent is to stay informed about costs and guide them on how to structure their student loans. When used responsibly, student loans can be a good alternative for your student to fund their education and set themselves up for professional success. As with all educated financial decisions, learning about student loan options and what they mean for the future is an opportunity for your young adult to develop important money skills that can help them for years to come.