Whether you’re planning to go back to school or already enrolled, a student loan is one of the most common types of debt. Understanding what a student loan is, how it works and what types are available can help you make wiser decisions about how to finance your education.
There are two primary types of loans – federal and private – that offer varying interest rates, repayment terms and borrower protections. The key is to compare and read the fine print before signing anything.
How it works
Getting a student loan is often the only way to pay for school. It can make a huge difference in your educational and career path, and it’s important to understand how it works so you can choose the right type of loan for you.
The process of getting a student loan starts with filling out the Free Application for Federal Student Aid (FAFSA), which gathers financial information about you and your family. It’s a good idea to fill it out as early as possible each year. This allows the government and your schools to crunch some numbers so you can get a more accurate estimate of what you’ll be approved for in the form of financial aid.
After your FAFSA is processed, you will be given an award letter from your school that shows what you qualify for in the form of grants and loans. Each school will disburse these funds in different ways, but they usually go toward tuition and fees, room and board, books, and other education-related expenses.
Once you’ve received your loan, you’ll need to start paying it back. Most student loans have a set repayment plan, with either a fixed or graduated interest rate.
You’ll also have a choice of repayment options, such as deferment or forbearance. Forbearance temporarily suspends your loan’s payments, allowing you to get through an unexpected setback while still making your regular monthly payment.
Forbearance can be useful for students who are unable to make their monthly payments due to financial hardship, such as unemployment or an unexpected illness. However, it is not a long-term solution and can lead to higher interest rates when you do resume your payments.
When it comes to repaying a student loan, the most important thing is to stay focused on the long-term goal of paying off your debt. This can be difficult to do in the short term, but it’s best to take the time to get organized and make a plan that works for you.
One way to keep your financial situation under control is to find out about income-driven repayment plans, which allow you to adjust your payments to fit your income level. This can help you avoid high interest rates and keep your finances stable in the long run.
The interest rate on your student loan determines how much you’ll pay over time. It can also affect your long-term financial goals, such as buying a home or contributing to retirement plans. The good news is that student loans often come with low rates.
The bad news is that interest rates can easily add up over time. And that can be a problem if you don’t watch your spending and repay your debt responsibly.
There are many different factors that affect the interest rate on a student loan, including market conditions, your credit history and your income. Generally, the shorter your loan term, the higher your income, and the better your credit, the lower the interest rate you’ll pay on your student loan.
A federal student loan, for example, typically has an interest rate that’s fixed throughout your entire loan term. However, a private student loan might have a variable interest rate that changes over time depending on market conditions.
For example, the Federal Reserve recently raised interest rates for federal loans. This rate hike is also influencing the rates on new private loans.
Since 2013, interest rates on federal student loans have been set based on the 10-year Treasury note rate following the May auction (which was 2.13% for 2019-20). This rate margin is 2.05 percentage points for undergraduates, 3.60 percentage points for graduate students and 4.60 percentage points for PLUS loans.
If you’re a first-time borrower, it’s best to start with federal student loans because they have lower interest rates than private student loans. Regardless of the type of loan you choose, it’s important to shop around and compare all your options before making your decision.
You can save a lot of money by paying your student loans off as soon as possible. This is known as income-driven repayment, and it’s a good way to reduce the overall amount of your loan that you have to pay back over the life of your loan.
Another way to save on interest is by keeping your principal balance low, which will help you avoid compounding interest and reduce your monthly payments. In addition, making extra payments can help you to get out of debt faster and reduce your total interest paid.
Taxes are a big concern for many college students. Whether they have student loans, grants or scholarships, they need to be prepared for the tax burden and make sure they take advantage of any benefits available.
For starters, you can deduct interest on student loans and free money used for school isn’t taxable. You also can’t report the money you use for room, board or textbooks as income.
You can also deduct the money you spend on books and other educational materials, as well as on computer equipment or software. This is called “qualified education expenses,” and it’s a good way to reduce your tax bill.
There are some exceptions to the deductible amount, such as if you’re in an income-driven repayment plan. You can’t claim this deduction if you’re married or filing jointly, or if your modified adjusted gross income exceeds a certain amount.
In addition, the federal government isn’t taxing canceled or forgiven student loans through 2025. However, some states will start taxing them as of this year, and borrowers should be prepared to pay taxes on the amounts they’re canceled.
North Carolina is the first state to tax student loan forgiveness. Despite the fact that Congress passed a law in 2021 that says canceled or forgiven student debt won’t be taxed until 2025, the state’s General Assembly decided to do something different.
It’s unclear why the state legislature decided to tax student debt relief, but officials are keeping an eye on any enactments that could change that.
Several other states, including California and Pennsylvania, have said that they don’t expect to impose taxes on student debt cancellations. These states have eight classes of taxable income, and student debt forgiveness has historically been treated as fitting within those groups.
In contrast, Wisconsin has a “conformity date” of 2020 and will begin taxing student debt cancelation beginning in that year. That’s why if you live in Wisconsin, it’s important to keep an eye on the policies of your state’s legislature and stay abreast of any changes.
If you’re worried that your canceled or forgiven student loan may be taxable, you should consult with a tax professional before filing your taxes. You can also check the IRS website for information about your options.
When it comes to student loan repayment, there are several options. These depend on the type of loans you have and your current financial situation.
If you have federal loans, you can choose from a variety of different plans to repay your debt over time. Some of these plans allow you to pay smaller payments over a longer period of time, which can save you money in the long run.
Another option to consider is making extra payments during your grace period. This can help you whittle down your balance faster, especially if you have extra cash to put toward your loans each month.
Also, you can apply extra funds to your principal if you have windfalls like bonuses at work or a tax refund that you can use to make larger payments. Be sure to set up autopay or a direct deposit so that these payments will count toward your payment.
Choosing the right repayment plan is essential to helping you pay off your student debt. The standard 10-year federal loan repayment plan is a good place to start, but you can opt for a 20- or 25-year plan if you want to speed up your payoff timeline.
The federal government also offers income-driven repayment programs to help you lower your monthly payment. However, these programs tend to lengthen your loan term and can cost you more overall, so if you’re trying to pay off your student loans quickly, it may not be worth choosing an income-driven repayment plan.
For more information about repaying your federal student loans, visit the Department of Education’s website. Its Repayment Estimator can help you determine your monthly payment amounts, and you can sign up for free appointments with Powercat Financial on campus to review your options.
Once you have a repayment plan, make sure to check your loan servicer’s website frequently for updates and alerts. This will ensure that you know when your payments are due, how much to pay, and any special instructions you may need to follow. You can also contact your loan servicer if you have questions or concerns about your payment schedule.