If you are planning to use financial aid to pay for your college education, there is a good chance you will have to apply for student loans. Unlike grants and scholarships, Loans are usually included in a financial aid package and must be repaid with interest. No two loans are the same, so it is important that you understand the basics of borrowing money before you apply. To start, all loans include three parts: the interest rate, security, and term.
The Interest Rate
The interest rate is a small percentage of the amount loaned that a lender charges for borrowing their money. There are two different kinds of interest rates: variable (also called adjustable) and fixed. Often changing over time, variable interest rates are typically centered on a standard market rate, such as the prime interest rate. The prime interest rate is the lowest interest rate a bank can offer a preferred borrower at the specific time and location that they are applying. For example, if you take out a loan with a variable rate of prime +2, you will pay two percent over the prime rate no matter what. On the other hand, fixed interest rates are unchanging, so the same percent will apply for the duration of the loan. Interest rates are a standard addition to most student loan programs.
The Security Aspect
All loans are either secured or unsecured, depending on whether collateral is required to guarantee the loan. If you have a secured loan, you have guaranteed the lender that you will pay back the money in some form, often by providing a claim on a valuable asset that you already own. In a secured loan, the lender can take the collateral if the loan is not paid. Because this guarantee provides high security, lenders can charge lower interest rates.
Requiring no collateral, the lending institution has no protection if an unsecured loan is not repaid. Almost always with higher interest rates, unsecured loans often require a co-signer who is legally bound to repay the loan if the borrower cannot. No collateral is required for most student loans, but interest rates are still low.
The loan term is the maximum amount of time an individual has to repay the loan. Most student loans have 10-year repayment terms. In general, a longer term results in a higher interest rate. As a rule, student loans can be repaid in full before the term ends.
Sources for Student Loans
Generally, there are two primary sources from which student loans are issued: the federal government and private lenders. To receive most federal student loans, you will first need to complete the Free Application for Federal Student Aid (FAFSA).
Federal, State and Private Loans
Federal loans make up nearly half of the total financial aid awarded to undergraduate students every year. Typically, federal loans are less expensive than state and private loans. While state agencies offer state loans, private loans are offered by various sources, including financial institutions, private foundations, and some colleges and universities. In general, state and private loans are unsubsidized, non need-based, and come with higher interest rates. In addition, for students with more than one student loan, there are services like Student Loan Consolidator that may allow one to consolidate their various loans, making repayment simpler.
Need-Based vs. Non Need-Based Loans
Loans are commonly divided into two main types: those that are based on financial need, and those that are not. Need-based loans are only awarded to students who have demonstrated the adequate amount of financial need on their FAFSA. Usually, need-based loans come with better terms and lower interest rates than most other forms of credit. With need-based loans, the borrowed does not have to start repayment until after graduation. Need-based loans are also subsidized, meaning that the government pays the interest for you while you are still attending college. Non need-based loans are intended for individuals who do not demonstrate a financial need, but are still unable to pay the costs of college based on their income and savings alone. These loans are usually unsubsidized, forcing the student to pay interest.