Student Loans – A Primer – Part 2

In our last post we told how Jason and his friends knew very little about the student loans they had. Only Jason appeared to be concerned. That changed and now Terrell, Olivia and Kate are worried about their student loans. Except for Olivia, who is a junior, they are all seniors and just months away from graduation

Borrowing money to pay for college is complicated, and so it is easy to make serious mistakes if you don’t look at all the details. In this post we will give you just the most important facts and some advice to pay attention to in making decisions about borrowing money for your postsecondary education. In a later post we will talk about how much to borrow. This is information parents and students all need to know, so let’s get to it.

There are two types of federal loans available to postsecondary students, whether they are in college or in a trade school or other federally recognized postsecondary education. Part of the difficulty in understanding the available loans is the language used in talking about loans and borrowing. This is where greater financial literacy is a big help.

Students can borrow a Direct Subsidized Loan or a Direct Unsubsidized Loan. Why are they called “Direct” and what is the difference between “Subsidized” and “Unsubsidized”? Direct simply means the loan is borrowed directly from the U.S. Department of Education. Once you know that you don’t have to worry about “direct” anymore.

In the context of a student loan, subsidized means that you, the borrower, are being given a loan without having to pay interest until six months after you graduate or leave school before graduation. If you have an unsubsidized loan, it means that interest is charged from the moment you receive the loan all the way through until it is repaid in full.

This leads to another term, accrue. When speaking of loans and the interest we pay on loans, we say the interest accrues, or accumulates, over time until the loan is repaid. So, with a subsidized loan, the federal government is lending you the money without charging you interest until you graduate or leave school before graduation. No interest is accruing. But with an unsubsidized loan, interest begins accruing from the day you receive the loan. For this reason, it’s a good idea to pay this accruing interest as you go through college because it can add up to a significant amount of money.

The current interest rate is a fixed rate of 2.75%. Because it is a fixed interest rate, it won’t change for the life of the loan whether it’s a subsidized or unsubsidized loan. Note: This does not mean that every direct student loan you take out while in college will have a fixed rate of 2.75%. The Education Department can change the rate, up or down, each year, so that the next loan you take out could have a different fixed rate.

Interest rates for direct subsidized and unsubsidized loans for 2019-2020 was 4.53%. Students returning to school for the 2020-2021 school year were happy to learn that the interest rate on their new loan would be 2.75%, a very large decrease when talking about loan interest rates.

At this point, Jason, Terrell, Olivia and Kate felt a little overwhelmed with all this information, and they suspected there was a lot more coming. They were right. But for now, just know that their loans are all different even though they all have direct subsidized and direct unsubsidized loans.

Jason is a fifth year senior, so he has been accruing interest for nearly 5 years on his unsubsidized loans. The total amount a student is permitted to borrow under the direct student loan program is $31,000 and no more than $23,000 can be subsidized. Jason reached his $31,000 limit and has $8,000 in unsubsidized loans. The interest rates on Jason’s loans have changed every year from 2015 to 2020. The interest rate has been as low as 3.76% and as high as 5.05%. Jason also has two private loans totaling $15,000 which his uncle cosigned.

In future posts we will talk about the loans Terrell, Olivia and Kate have, but Jason’s loan status shows how borrowing over several years can be complicated and expensive. Jason didn’t understand this, and now he has to sort out his multiple loans and begin to think how he is going to repay them. He is especially worried about not putting his uncle in a difficult position if he is unable to repay his private loans. If you are a high school junior or senior planning to attend some kind of postsecondary education you will have to pay for, you would be wise to read this over again and begin to look into some of the financial literacy resources listed in earlier posts. Jason has our sympathy, but he’s not alone. Begin now to put yourself in a position where you won’t need our sympathy. If you don’t, four or five years from now sympathy is all we will be able to offer.