By Carol H Cox
photo: www.cafecredit.com
It’s no secret that American private colleges and even many public universities are absurdly expensive these days. In the process of weighing acceptance options, high school seniors will be reviewing financial aid packages and may be considering signing up for student loans. It’s important for everyone involved, students and parents alike, to educate themselves about what a student loan really involves.
Let’s assume that that a student is an absolute newbie to the world of debt—she has never taken out a loan before. The student may have a vague idea of what a loan involves—borrowing money from someone or some institution and then paying it back over a fixed period of time.
A loan is a promise made by a borrower, to pay back the lender all of the money that was borrowed, along with interest, at regular intervals (usually monthly) over a specific time period (the loan term). For instance, a student might take out student loans totaling $15,000 at an interest rate of 4 percent, to be repaid over a period of 10 years (the standard repayment term for federal student loans). This would mean making monthly payments of $152 for 120 months, altogether $18,224, including interest.
There are simple online calculators that you can plug variables into (the loan amount, interest rate, and loan term) to get the monthly payment amount. It’s important for students to get use to framing what a loan truly requires, in terms of what the actual cash outlay will be every month and for what length of time. In other words, students are wise to use actual numbers, and to not accept vague generalities or incomplete information about student loans, because this will ultimately be the student’s financial responsibility. Students can translate that $15,000 number into a real this-is-what-I-have-to-live-with-for-120-months-of-my-life kind of a commitment.
Now, there are also flexible repayment plans available for federal student loans. These plans can reduce a borrower’s monthly payments, making them more affordable. Of course, as a result the borrower will be repaying the loan over a much longer time period and this will mean the total amount paid (the amount borrowed plus interest) will be much larger.
For instance, there are income-based repayment plans available that will determine the borrower’s monthly payments using her actual income. If a borrower’s annual income is relatively low, this would likely reduce monthly payments as compared with the straight 10-year repayment plan, but in return the borrower payments may be stretched to 20 or 25 years—that 120 months stretches to 240 or 300 months. This means the total amount a borrower pays over the life of the loan is a lot more than what would have been paid under the 10-year repayment plan. But perhaps this is the only way a student can afford a sizable loan and she would be willing to make that commitment.
(Note: there are also some federal student loan forgiveness provisions for borrowers who work in qualifying public service jobs for a given number of years while repaying student loans and who have signed up for certain income-driven repayment plans.)
Students considering student loans need to ask themselves how much are they willing to sacrifice. Can they handle this amount of debt? Will it cause them great stress? Will this greatly restrict their job options or impact their future family plans?
Drawing up a post-college/graduate school budget is a useful exercise for students to get an idea of what life might look like financially for them in the future.
It’s perhaps too easy for young adults to sign up for student loans. As an undergraduate student taking on federal student debt, there’s no credit check required and no parental co-signing required. No one is necessarily going to look at their situation and tell them how much, if any, they should take out. As of today, the federal government will loan students up to $31,000 over the course of their undergraduate years, which is a pretty sizable sum of money for someone in their early 20s to be responsible for repaying. And private financial institutions will loan a student even more (with parental co-signing). However, if a student has to start taking out private loans, that’s a serious indication that the school isn’t really affordable unless other financial aid is offered.
According to the U.S. Department of Education, 11% of student loan borrowers are in default (meaning they are unable to make their required payments as agreed). And this suggests that all is not well. Student loans will stick to a person like glue. They don’t go away simply because a borrower is having difficulty repaying them or didn’t finish her degree program. Student loans can mess up a person’s credit history and score if payments aren’t being made per the loan agreement.
During the selection process, it’s important for students to carefully weigh the financial aid package being offered by each of the colleges, and especially the size of student loans, if any, included in the package.
Student loans are called financial aid, but it would be better to call them what they really are: debt. Students may want to keep this in mind when making their final college decisions.