Whether you have $2,000 in student loan debt or $100,000, knowing all the different aspects of a student loan is important because it will help you to build an effective plan for paying it off.
In the most basic sense, a student loan is a form of debt. Debt means that you as the debt holder owes the debt provider or lender money. The lender demands payment for you to use the debt and that payment comes in the form of interest.
There are four main parts of student loans that we’ll dive into:
1. Issuer: Federal vs. Private Loans
2. Principal Amount: Original amount of the loan
3. Interest Rate: Cost of borrowing
4. Repayment Term: How long you have to repay the loan
Issuer: Federal vs. Private Loans
Federal student loans are provided by the federal government while private loans may be offered from multiple sources including banks and credit unions.
Federal student loans offer many benefits including loan forgiveness programs and fixed interest rates.
Generally, private loans are taken out to bridge the gap between the federal loan limit and the borrower’s need.
Private loans are subject to the policies of the individual lender. Since private lenders do credit checks, depending on your financial situation, private loans could cost more or less than federal loans in the long run.
Principal Amount: Original amount of the loan
When you take out a loan, you will be given an amount, say $6,000. That original amount is called the principal. Your principal is one consideration that lenders make when determining your monthly payments and how long they will give you to repay it.
The larger your principal, the larger your monthly payments and the longer it will take you to repay the loan.
Interest Rate: Cost of Borrowing
The interest rate will determine the extra amount that you pay to the lender to essentially compensate them for letting you borrow the money in the first place.
Although high interest rates will lead to you paying more than you originally borrowed, there are ways to minimize these interest payments.
Private loans have a wide interest range that generally depends on your financial situation. This is a good thing if you find yourself in a better financial situation after graduation because you may be able to leverage refinancing to your advantage.
Currently (August 2020), federal student loans are in a relief period where the interest rate is 0%. This is a great time to pay down the principal of the loan without having to pay any interest.
Repayment Term: How long you have to repay the loan
All loans have a set repayment term that depends on the size of your principal, your interest rate, and what your monthly payments are.
A common repayment term is 10 years, but there are various term lengths your loan may follow.
Instead of a fixed length loan, there may be other repayment options such as income-based repayment. This would make your loan payments dependent on your income. When you are earning less your payments would be lower and vice versa. The most popular repayment plan is fixed-length term.
There is no penalty for paying off student loans faster than the repayment term dictates. This is a great option for people that are financially able to do so because it will save you money in interest over time since there won’t be as long of a period for interest to accrue.
Now that you know. . .
Now that you understand all the different parts of a loan better, it’s a great time to understand YOUR loans. There are a few things you can do to get a big picture of your loans.
1. List out every single loan you have and include this info: issuer, principal, interest rate, monthly payment, repayment term.
2. Once you’ve done that, calculate how much interest you will owe over the lifetime of your loans using this calculator (you will have to enter each loan separately and add up the total interest paid for each loan). Also, click on the amortization schedule for each loan to see the exact numbers behind monthly interest, how your balance decreases over time, etc.
3. If step two made your jaw drop, play around with adding additional payments on the calculator. It gives you an option to add extra payments monthly, annually, or in a one-time lump sum. You can see how much faster you will be able to pay off your loan or how much interest you will save.
4. If you think that you could benefit from refinancing student loans, use this calculator to start exploring how lower interest rates could affect your total payments.