Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Student Loan

What is a Student Loan?

A student loan allows someone to borrow money to pay for the costs of education as they attend a college or university. A student loan is typically expected to be paid back over a 10-year period, but can be paid back over 20 or 30 years if the borrower is struggling to make monthly payments.

Student loans can sometimes be forgiven, too, as we talk about in How to Get $45,000 in Student Loan Debt Forgiven in 6 Steps

Both private and federal student loans have become the norm for most people seeking higher education, which continues to get more costly every year. They do come with risks for the borrower, especially if they're unable to afford the monthly payments six months after graduating or dropping out. But as long as colleges and universities continue offering an attractive path for people to potentially land higher-skilled jobs and earn higher salaries after graduation, student loans may continue to be considered a worthwhile investment toward a person's future earning potential.

 

How Student Loans Work

Student loans have become a necessity for most people attending colleges and universities in recent times as the costs of tuition, room and board, books, and other fees related to higher education continue to rise.  

Unlike traditional loans, the vast majority of student loans do not require income or a person's credit history to obtain, as long as their school of choice meets certain education program requirements.

The downside is, student loan debt may be forcefully collected from the borrower if they fail to make payments (via wage garnishment or seized tax refunds, for example), and the loans may not be forgiven if the borrower goes bankrupt except in certain cases of "undue hardship." 

Student loans are funded by the US Treasury Department, passed through the US Department of Education, then passed on to colleges and universities, and then on to parents and students (depending on the type of student loan). Student loan servicer Sallie Mae collects on most student loans in the United States.

Federal Student Loans: Subsidized Vs Unsubsidized

While private student loans are available through some lenders, most students go through the Free Application for Federal Student Aid (FAFSA) process to potentially obtain federal student loans, which typically carry lower interest rates than private student loans. 

Federal student loans are split into two main categories: "subsidized," where the government pays the interest on the loan while the student is in undergraduate school at least half-time (6 credit hours or more); and "unsubsidized," where the student loan accrues interest after they get the loan.

The borrower is expected to begin making payments on both types of federal student loans after a six-month "grace period" following their graduation or if the student drops below half-time status.

Federal student loan funds can be issued either to students directly via Perkins or Stafford loans, or to parents through PLUS loans, which can extend more loan funding than the student loans but require that payments start immediately.

Student Loan Consolidation and Repayment Plans

Assuming the borrower doesn't alter their loans after graduation (or dropping out), a student loan is typically expected to be paid back over a period of 10 years after the six-month grace period. 

If a student chooses to change their repayment plan to a Direct Consolidation Loan or FFEL Consolidation Loan, the repayment period may be extended depending on how much the student owes.

According to the Federal Student Aid office of the US Department of Education, this is how the repayment schedule goes under these consolidated loan types:

If Your Student Loan Debt Equals...
At LeastLess Than...your Repayment Period will be...
$0$7,50010 years
$7,500$10,00012 years
$10,000$20,00015 years
$20,000$40,00020 years
$40,000$60,00025 years
$60,000 30 years
Source: Federal Student Aid Office of the US Department of Education

In case you're wondering, the typical graduate left school with $37,172 in student loan debt in 2016. Using a loan calculator, we would find that $37,172 paid back over 10 years at a 7% interest rate would mean payments of $431.60 per month to repay the student loan. The calculator also shows you would pay $14,619.81 in interest over that time period, assuming you didn't repay the loan earlier or delay on your payments.

Need more answers? Check out these student loan articles from InvestingAnswers: