Student Loans 101: What to Know Before Your Kids Borrow

We all know that college is expensive. And running the numbers makes it all the more stress-inducing. According to the College Board, the price tag for tuition and fees at a public, four-year college for out-of-state students was $28,240 in the 2022-23 school year. That’s nearly $113,000 spent over a four-year college career.

But if you haven’t managed to put quite that much away in a 529 college savings plan, that doesn’t mean college is out of reach for your aspiring coed. Fortunately, student loans are available to help foot the bill.

Still, the decision to take on student loan debt is a big one. Before your child starts the loan application process, it’s important they know everything about taking on student loans so they don’t leave school clueless about managing their debt. Here’s what you need to know.

Public student loans

Interest rates

Student loans can be either public or private. Public loans are also called federal student loans because you’re borrowing from the federal government, and the interest rates on them are set by Congress. For loans disbursed on or after July 1, 2023, rates range from 5.5 percent to 8.05 percent. These depend on what type of loan you’re applying for, and whether you’re an undergraduate or graduate student, or a parent borrowing to help your child.

Subsidized vs. unsubsidized loans

Federal student loans can also come in two varieties: subsidized and unsubsidized.

For a subsidized loan, borrowers don’t pay interest while they’re in school, during a six-month grace period after leaving school, or if the loan is in deferment (meaning they’ve been able to temporarily postpone loan payments). That’s because the interest during those times is being footed by the government. Only undergrads are eligible to receive subsidized loans, and the amount they get is determined by financial need.

For an unsubsidized loan, which both undergrads and graduate students can get, the borrower does not get any help with the interest. This means the borrower must pay it, but they have options for how to pay. They can pay for the interest while in school or choose to let it accrue while hitting the books and then let it capitalize—that is, get added to the loan principal. (Choosing the latter will ultimately increase the amount they’ll end up owing.) The borrower does not have to demonstrate financial need to be eligible for an unsubsidized loan.

Application process

To apply for federal loans, students and their parents must fill out the Free Application for Federal Student Aid (FAFSA), which helps determine how much financial aid they are eligible to receive—whether in the form of student loans, grants, or federal work study. This information usually appears in the student’s college financial aid package.

For the 2023-24 school year, the federal deadline to apply for financial aid is June 30, 2024. But colleges often have earlier due dates, and certain forms of funding are paid out on a first-come, first-served basis. That means that it can pay—literally—to be early.

Private student loans

Interest rates

Private student loans are those issued by banks and other lenders. Because these institutions are free to charge whatever interest rates they see fit, private loans typically carry higher interest rates compared to federal loans—potentially much higher.

Additionally, an interest rate on a private student loan could be fixed or variable, meaning the rate may change over the life of the loan.

Application process

Students can apply for private student loans much the way they apply for any other type of loan: Fill out an application with a private lender, who will determine how much to offer them and at what interest rate based on their creditworthiness (how likely the lender believes the students will be to pay the loan back). A private student loan lender will determine this based on a borrower’s credit score and the information in his credit report. If the borrower doesn’t have much of a credit history, then the lender may require a co-signer.

Public student loans tend to be preferable to private student loans because the federal government offers more flexibility when it comes to borrowing and repayment. And, as mentioned above, interest rates for private student loans tend to be higher than for public ones. But private loans can be a good secondary option if a student doesn’t receive enough financial aid to cover college costs.

Paying back student loans

When it comes to paying back student loans, the federal government provides more flexibility compared to private lenders, as well as the possibility of public service loan forgiveness, which relieves some of a borrower’s balances if he or she works in a qualifying public-service job for a certain amount of time.

Case-in-point: Student loan payments on federal student loans have been on pause since March 13, 2020, when Congress passed the CARES Act at the onset of the global pandemic. Payments are currently set to resume in October.

Some private lenders may offer public loan-type features, including the ability to reduce or halt payments because of financial hardship. However, a borrower will generally have more repayment options with federal loans—which is helpful for someone who ends up in a tough financial situation. These options can include:

• Graduated repayment, which starts with a lower payment earlier in the payment timeline and then gradually gets larger.
• Extended repayment, which extends the timeline beyond the typical 10-year repayment period.
• Income-based repayment plans, which set a monthly payment amount based on how much the borrower makes.

But keep in mind that some of these plans could increase the total amount a borrower ultimately owes, because you’re still accruing interest on your overall balance—even if your actual payment due has been lowered.

Federal loan borrowers may also be eligible for deferment or forbearance—temporarily suspending payments—for a period of time if they meet certain eligibility requirements. The primary difference between the two is whether interest accrues during the time the payments are halted. In deferment, subsidized loans don’t accrue interest, but unsubsidized loans do. In forbearance, both subsidized and unsubsidized loans accrue interest.

If in the future your college grad thinks they can lower the interest rate on their federal loans by refinancing them (i.e., selling them to a private lender), remind them that privatizing those loans may mean losing the protections and flexibility mentioned above.

Another option: If a borrower has multiple federal loans, they can consolidate them into one and make a single monthly payment. That won’t lower the interest rate, as the new interest rate will be a weighted average of the interest rates on all the loans. Plus, consolidating takes away the ability to get strategic about paying off debt more aggressively by prioritizing those loans with the highest interest rates and balances. But it can make it a little easier to stay on top of repayment compared to juggling multiple loans.

The bottom line on student loans

Student loans can be a powerful tool, helping your child pay for a college education that they otherwise might not be able to afford. But they also come at a cost, and not all student loans are created equally. Before your child borrows a student loan—whether from the government or a private lender—it’s important for them to know they work.

If you’re still in the college planning phase and thinking of ways to help your child pay for college with fewer student loan, a financial advisor may be able to help.