If you are going to embark on an educational journey, you might be thinking about applying for a student loan. You might be wondering if student loans are worth it in the long run. Before making any bold decisions, you must learn more about how student loans work. You would want to carefully weigh the pros and cons of taking out a student loan to take care of your expenses in uni. Different features of student loans may appeal to different borrowers depending on their needs. Weigh the positives and the negatives and make the decision that will be best for you.
TABLE OF CONTENTS:
- Pros of Student Loans
- Cons of Student Loans
- Pros of Federal Student Loans
- Pros of Private Student Loans
- Cons of Federal Student Loans
- Cons of Private Student Loans
Pros of Student Loans
The following are some perks that student loans can offer you:
Student loans allow you to afford college
A very small percentage of Americans find themselves capable of affording a good quality college education. Everything in college costs and everything is expensive. This includes expenses for tuition, room, and board. It is near impossible for a ton of kids already in college to afford such an expensive affair without the help of student loans.
Student loans can help you land your dream school
Private colleges cost a bomb when compared to public universities. If the course that you have been looking for is offered by a public university, then well and good for you. It will allow you to graduate from college without racking up a ton of debt. But if your dream has always been to study in an elite, private university, your only shot at landing an acceptance there would be via student loans. Financial aid can only cover so much. Student loans offer you a choice between affordable and expensive schools.
Student loans can be used for affording numerous amenities
You could devote your student loan money to afford several essentials like textbooks, a laptop, and computer software, as opposed to what most people think. Usually, people think student loans can only be used for tuition, room, and board. The fact also remains that making such overlooked, yet important purchases with money out of pocket or credit cards or personal loans can make you incur more interest.
A good opportunity to build credit
Paying off your student loans is one of the best ways by which you can build your credit scores fresh out of uni. A lack of other bills and debts often makes student loans the only means by which students can build their credit history. A good credit score is always a great thing to hold. It can help you afford good apartments, apply for credit cards and jobs, etc. But bear in mind that for this to happen, your repayments have to be on time. Try to make interest-only payments while in school to lower your balance. Learn more about student loan repayment.
Cons of Student Loans
The following are some cons of taking out student loans:
Student loans are often expensive
It is no secret that student loans are expensive by nature. You will not only be paying the amount that you borrow to cover your educational expenses, but also interest on the principal. Federal interest rates range from 4.45 to 7% while private student loans have rates that range from 11 to 15%. This is comparable to credit cards. If you can afford to finish your education without student loans, it would be advisable to go for it.
Student loans mean you start your career in debt
The first few years of your career/work are likely to be a difficult time with student loans. You will be indebted straight of uni. The number of years that you will be indebted depends on the amount that you borrow and the kind of job that you will land, if at all. This is because once you start earning, you will also have a ton of other responsibilities and expenses that you will have to cater to.
You put your other life goals on hold because of student loans
The money that most graduates set aside for monthly student loan payments is quite high. This is money that you could be investing elsewhere. You are forced to put a lot of other financial goals on hold due to your student loan payments. You will likely only be able to pursue them once you pay off your student loans.
Student loans persist even if you can not pay
Bankruptcy can be declared if you find yourself in a position where you can not afford to pay your mortgage or your credit card bills or any other bills. This is no joke, however, because declaring bankruptcy can have devastating effects on your credit score. These effects are lasting, too. This is why even though you can avail of a great extent of relaxation on your bills, you should not declare bankruptcy unless there is an emergency. Discharge of student loans under bankruptcy happens very rarely, which is not a perk for people who unfortunately find themselves unable to pay.
Defaulting on your student loans can affect your credit score badly
Taking out more than you can afford to repay, not making your payments promptly, and worse, defaulting on your student loans can all have adverse effects on your credit score and can severely damage your credit history. With federal loans, your loan will be declared as “default” after 270 days of no payments, which is by no means a good label to have on your record. A bad score can haunt you for a long time to come. You will ultimately have to pay more on mortgages or credit cards. However, there are several plans and repayment methods available for borrowers should they find themselves unable to make their payments on time.
Pros of Federal Student Loans
Anyone who is planning to take out a student loan is advised to exhaust their federal options first before moving on to private options. The following are some perks that federal loans offer.
Affordable interest rates and fees
Federal student loans come with comparatively lower interest rates. It is no secret that private student loans generally have bigger interest rates and for a lot of people are unaffordable. Federal student loans also have the added advantage that the rates that they offer are mostly fixed. This means that for the entire duration of your repayment, the interest rate will not change. With the Federal Reserve interest rate benchmark very private student loan interest rates.
Excellent credit is not a requisite
To avail of a good private student loan with a good, low-interest rate, borrowers have to have a good credit history. Private student loan lenders want you to display to them an ability to repay without any hassle within your stipulated term. Your credit history and score will also be key factors in deciding the interest rate that you will end up with. Since undergrads are merely starting with their professional lives, most of them do not have any credit scores or short credit histories, i.e. low credit scores.
Federal student loans, on the other hand, can be easily availed by any enrolled undergraduate. Only direct PLUS loans require a credit check. These are available to grads and parents.
It is advisable to exhaust your federal loan options before moving on to private student loan lenders since federal student loans come with a ton of benefits, as we will see. Submit the Free Application for Federal Student Aid (FAFSA) to see what federal loans you are eligible for.
You may seek the help of private student loans too if you have a gap in your education budget that needs to be taken care of
A cosigner is not a necessity
Students are not likely to have elaborate credit histories displaying their ability to repay. For most private student loans, a cosigner is required to qualify for these loans. This could be a parent or any adult willing to back the student financially and be present as moral support. They essentially agree to repay the loan if the student can not. Inviting as this may sound, it can be quite dangerous, in the rare scenario that the student fails to repay on time. This is quite a huge responsibility to infer upon someone and can be quite burdensome on them.
Since federal loans do not look at your credit history, they do not require a cosigner to be present with the student/borrower. This means that no one else has to worry about your student loan payment status if you can not pay.
Flexible with a pause of payments
If you face economic hardship, you may defer your federal student loans for up to three years. In this aspect, private student loans are rarely flexible, and very less so. They mostly offer postponements on payments for 12 months in three-month increments.
Subsidized loans accumulate less interest
Direct subsidized loans are easy to qualify for by students with high financial needs. When in deferment, while in school, during your grace period and if you choose to take a break from your student loan payments, the government offers to pay interest on these subsidized loans. You can not avail of such benefits on private student loans. They start collecting interest, along with unsubsidized federal loans, from the day they are paid to you.
Income-driven repayment options
A percentage of your income can be paid every month as student loan repayment. This can even be lowered to $0 if you do not have any income. Your payments can be lowered this way with federal student loans. You will have to apply every year and you can pick a plan that is most suitable for you. Private student loans are not flexible. The best that you can do would be to contact your servicer or lender and talk to them about lowering your interest rates briefly.
Student loan defaults after a good period
Most private student loans often go into default when borrowers miss even a single payment. This could easily damage your credit and gives your lender opportunities to sue you, even though the federal government has numerous means to get your payment while private lenders do not.
Having said that, federal student loans give you a lot more time to catch up with your payments in case you fall behind. Your student loans will not be labeled as “delinquent” and your loan status and inability to repay will not be reported to the credit bureau for up to three months. Your loans will default only after nine months of missed payments, which is a very good period, considering how private student loans default immediately after a payment is missed. Once your loan defaults, the government has the authority to take money directly from your paycheck or tax return as repayment.
Good credit is not a requirement for loan consolidation
Multiple federal student loans can be consolidated into one month for efficient payment and hassle-free management. One advantage of federal consolidation is that some of your loans will be made eligible for Public Service Loan Forgiveness(PSLF) and income-driven repayment plans. Note that it will not save you any money, since the interest rate will be determined by taking a weighted average of your previous/constituent loans’ interest rates. Consolidation can be easily availed without a credit check.
Refinancing and consolidation of your student loans can also be done through a private student loan lender. This can help you avail lower interest rates depending on your credit history, credit score, and income. But refinancing via a private lender can cause you to lose federal privileges.
Good student loan forgiveness options
With private loans, it is not common to find forgiveness options. You have to pay the full student loan balance. But with income-driven repayment, your federal loans can be dissolved after a certain period, if you still have an outstanding balance. This is also true if you choose to work for a nonprofit or for the government. Public Service Loan Forgiveness forgives federal student loans after ten years. Public service workers with Perkins student loans can avail forgiveness in an even shorter time.
Your loan will be canceled after your death
On an unfortunate occasion that you die or become disabled, your federal student loans will be discharged. This is also true for Parent PLUS loans taken out on the students’ behalf by their parents if the parents who hold these loans die. This is not heard of for private loans, although some lenders do offer discharges on death these days. Always enquire about the status of your student loan before taking one out to see what will happen if you or your cosigner dies.
Pros of Private Student Loans
Private student loans bring with several undeniable perks. Let us see what they are:
Private Student Loans can fill your financial gaps
If your financial aid package fails to cover all your expenses and you are out of cash, private student loans can help you out. Often students reach the federal student loan borrowing limits or can not qualify for any more aid or resources. You will look at your family or others to contribute to your educational expenses. A private student loan can be very helpful in covering up to your education’s full cost of attendance. It can cover the gaps between your financial aid package and your expenditure.
They are not financial need-based
As seen in the previous perk, students often max out on their federal options even before their needs are met. They further struggle to qualify for any more loans from the federal government. Most federal loans like Pell Grants, Perkins loans, and direct subsidized loans are need-based. That is, you can avail them only depending on the government’s estimate of how much you will need. Private student loans, on the other hand, aren’t based on financial need. This is why they are highly preferred for filling any gaps in your budget.
You do not have to fill any elaborate form, including the FAFSA
Private student loans do not require you to fill out any elaborate forms, including the FAFSA, which most federal student loans do. The Free Application for Federal Student Aid or FAFSA is a necessity to avail federal student loans and is mainly used as a tool to let the borrower know what federal loans they are eligible for. Not filling one out can not stop you from getting a private student loan for your studies.
Private student loan rates and terms are open to customization
If you are worried about repaying your student loan and are worried about the potential risk involved, then you frankly have nothing much to worry about. Private student loans come with a range of options to choose from. Most private student loan lenders offer both fixed and variable interest rate options. Some even offer custom, hybrid interest rate options. This is where a borrower may choose to stick to a fixed rate for a certain period and then move to a variable rate. You even have the liberty to pick a repayment plan that falls below your estimated risk tolerance. It is also important to note that different lenders come with their special benefits and features depending on your credit situation. You can also pick a term best suited for you.
Cosigners may participate
If you do not have a lengthy credit history to show and are worried about getting approved for a private student loan, you can relax. Most private student loan lenders permit the interference of a cosigner to increase your chances of getting approval. Their credit history can also help you avail better interest rates. Most private student loans also come with options to relieve your cosigner after a certain number of consecutive and timely payments.
Competitive interest rates and generally low fees
If you have heard that private student loan lenders charge a lot of fees and are expensive, learn that it is not always true. Many lenders often charge no fees. Their interest rates are also quite competitive with PLUS loan rates.
Benefits for good credit scores
With most federal student loans, your credit score doesn’t matter. Interest rates are the same for everyone regardless of your credit. With private student loans, however, you can receive rewards and benefits if you have good credit scores and history. This also applies to your co-signer’s credit history. You will find rates as low as 2.64% if you have a sufficiently good credit score. Most federal student loan rates are higher, depending on your course.
Cosigner release options
If you do not wish to impose on your cosigner the financial obligation of your student loan for a long time to come, private student loans might be a good option for you to consider. Cosigner release options are offered by most private student loan lenders where your cosigner may be relieved if you meet the lender’s requirements. Most often, you will be required to make a certain number of timely and consecutive payments before your cosigner may be released.
Student Loan Refinancing
Refinancing your private student loans in the future can be a good option for you. Refinancing is a great way to merge/consolidate all your loans into one for easy management or handling. This may also help you avail better, lower interest rates depending on your credit.
Processing of your application and disbursement of your student loan tends to usually be a much shorter and simpler process for private student loans. This can especially be a major perk for people with an urgent need for their funds.
Statute of limitations
There is no statute of limitations for when you default on federal student loans. Regardless of the duration for which your loan is in default or what may happen, you will eventually have to repay. There is no other way to go about it. Also bear in mind that the government has several means to get your money from you. Your wages and tax refunds may be garnishes as repayment for your federal student loans. With private student loans, there is a statute of limitations in place for when your student loan defaults. This may vary, anywhere between 3 to 10 years, depending on your state. After this time, however, lenders will have difficulty getting your money from you.
It is, however, very detrimental to your credit score to default on your student loans and is not advisable. However, if the worst were to ever happen, there is an expiration to a private student loan default.
Some other benefits
Private student loan lenders often charge no prepayment penalties. The interest here is tax-deductible and you may earn good interest rate discounts if you qualify.
Cons of Federal Student Loans
Benevolent as they are, federal student loans also, inevitably come with several cons that borrowers should be wary of:
No choice when it comes to loan servicers
You do not have the liberty to choose a loan servicer to issue and manage your federal student loan. This is quite a concern because student loan servicers do not have a great reputation for offering customer service. It is quite important to have a reliable team of customer service personnel to assist borrowers at all times with any queries or doubts that they may have. This is also not guaranteed with federal student loans. Over the lifetime of your federal student loan, you may have to deal with several servicers leading to miscommunication.
Both annual and aggregate limits are imposed on how much a student can borrow with Direct Subsidized and Direct Unsubsidized federal student loans. You can exploit a direct PLUS loan if you wish to cater to the total cost of attendance. If you have borrowed up to the limits permitted with federal student loans, then look into private student loans to bridge the gap. This is especially because Direct PLUS loans come with a high rate of interest.
Government’s ability to get your money
Despite a long time that it takes before your loan can default if unfortunately, you end up leading your federal student loans into default because of any hardship or inability to repay, the consequences may be quite severe. The federal government has wide-reaching power to get its student loan repayment money back. They may garnish your wages and your federal tax returns.
Federal student loans will not be discharged for bankruptcy
If you default for quite a prolonged period or are simply unable to repay your loans, you will not be able to escape your repayment responsibilities by declaring bankruptcy. Some slight relief may be offered to people who qualify for “undue hardship”, but it is very difficult to qualify for this category.
Certain subsidized Federal Student Loans are not applicable for graduate students
With Direct Subsidized Loans, the government does offer to make interest payments on student loans for undergraduates who meet the income eligibility criteria. It does not offer this loan type to graduate students. They may only avail unsubsidized loans.
Graduate students have higher interest rates
Higher interest rates are applied to federal direct student loans for graduate students when compared to those offered for undergraduates. This has been observed for quite a while now and this pattern is not expected to change any time shortly.
Loan limits are lower for dependents
If you are an undergraduate with a parent or a guardian whose tax return you are dependant on, you will not be eligible to borrow as much as the undergraduate students who file their tax returns.
Federal Direct loans are not available for those with any loans in default
If you currently have any loan in default, any application that you may make for a direct federal student loan will be automatically rejected. Any such defaulted loans will have to be dealt with before a Federal Direct Loan can be approved.
Loan fees are often charged
An organization fee of 1.068% is charged on all Federal Direct Loans, both subsidized and unsubsidized.
All schools are not eligible
Only schools that distribute Title IV student aid funds are those where Federal Direct Loans can be used. Most schools do not fall into this category and hence, do not qualify for this loan. Learn if your school qualifies.
Approval for one Federal Direct loan does not imply or guarantee approval for the subsequent years. You will have to make a new application every year.
Cons of Private Student Loans
The following are some downsides of private student loans:
Good credit is needed
It is possible to get a private student loan with a not-so-good credit score. However, it is quite difficult for borrowers to get a low-interest rate on their own. Borrowers with poor credit scores and histories may end up with higher interest rates. Because a lot of young borrowers do not have lengthy credit histories that do not justify them and limited income, quite a large number of people fall prey to large interest rates when compared to federal borrowers. This may even run into double digits.
Variable rates do not save you a lot of money
The risk with variable interest rates on private student loans is that the number may increase with time. Statistics show that variable rates have been increasing slowly and this trend is not expected to take a turn in the opposite direction any time shortly. So if you sign up hoping to pay less with a variable rate of interest, you may be surprised with higher payments in the future.
Lesser repayment and forgiveness options
Several government-supported programs can be pursued by federal student loan borrowers in case they encounter any financial trouble and find it difficult to make their monthly payments. These programs are designed to make their payments affordable. A classic example would be any one of the income-driven repayment plans that they can apply for. Under this plan, their monthly payments are adjusted to 10 to 20 percent of their income. This varies depending on the program chosen. Income-Driven Repayment plans also offer forgiveness on any remaining debt after 20 to 25 years of payment, depending on the course of study.
Numerous federal student loan forgiveness programs are also available to borrowers who work in public service. Borrowers will have to qualify for these programs. These forgiveness programs will erase any remaining debt after they make a certain number of qualifying payments. Private student loans usually do not offer any such plans. Struggling borrowers are at the liberty of their student loan lenders. They may choose to work out an alternative repayment plan depending on their client’s predicament. Private lenders rarely, if at all, offer student loan repayment assistance to their borrowers. Deferment and forbearance options are rarely available to borrowers facing difficulty with their payments. A private student loan borrower’s credit may get damaged faster than that of a federal borrower in case of delinquency.
Federal subsidies are not available
Most federal student loans come with an interest subsidy. The government will offer to pay for the interest on your student loan when you are in school or even in repayment if you qualify for a subsidy. Depending on your loan type, some federal student loans come with an interest subsidy. Interest does not accrue, which means you can save a lot of money. This, however, is an option that does not accompany private student loans. Interest starts to collect from the first day. Some loans even demand that you make interest payments while still in school. If you fail to make these payments, they are added to your overall debt which you will have to pay when you finish school.
A cosigner is often a necessity
While most federal student loans do not require the presence of a cosigner, they may be needed to avail of most private student loans. This may be the case even if you have good credit. This is mainly because private student loans expect you to make payments even while you are still in school. Since you will not be earning then, most private loans expect you to have a cosigner. A cosigner is legally responsible for the repayment of your student loans. If you, the student, fail to repay even once on time, the co-signer’s credit may be damaged and debt collectors can pester them for repayments, well within their rights.
Private student loans follow you throughout your life and even after
Most federal student loans die with you. They are not passed on to anyone since most of them do not even require cosigners. If you pass away, federal student loans will not count against your estate. This is not the case with private student loans. They will try to count against your estate. If you do not take a private student loan with a cosigner, private student lenders can not go behind your relatives. But they can lower the value of the inheritance that you leave behind.
Student loans are often, more or less, a necessary evil. They permit you to afford something likely to add value to yourself for the rest of your life, a good education. Paying them off can be quite the affair, but if done right, it will be worth it. It is always advisable to borrow only as much as you need and practice good repayment practices. Carefully look into both federal and private student loan options and pick whichever you think fits your bill. Learn more about student loan servicers and how they deal with student loans.