Student Loans and Strategies to Pay Them Off (Part 1)

Andrew Silver

November 11, 2019

Truth is lenders aren't evil...but the Office of Federal Student Aid hasn't exactly made everything easy for borrowers. Let's try to make some sense by breaking this student loan discussion into pieces.

As we approach the holidays, many college seniors are thinking the same thing. No…not, “time to pull that all-nighter to prep for my exam before my much needed holiday break.” Well, ok…they probably are. But what they should be thinking about is that boat-load of student loans they, their parents or, in many cases, both took to fund the last three and a half years of life will soon come due and a slew of lenders will be happily sending out the first round of invoices (insert evil laugh, hands greedily rubbing together and lightning crashes).

Truth is lenders aren’t evil…but the Office of Federal Student Aid (a part of the U.S. Department of Education) hasn’t exactly made everything easy for borrowers. There are many different types of loans, all of which are offered by the Federal Government, Private Lenders or both. Add on top of this eight different repayment options for federal loans and any number of factors that affect the best option to choose (e.g. the total amount of student debt, the type of job one gets out of college, the amount the one will earn from their new job, whether they are married or have children, and even the type of loans or combination taken thereof) and it’s enough to make your head explode.

*Phew* Head still attached? Hopefully so. Don’t worry…let’s try to make some sense by breaking this student loan discussion into pieces. Today’s blog, Part 1, will focus on the types of loans, their status as federal, private or both and whether or not they qualify for consolidation or the multitude of repayment options offered by the U.S. Government.

Federal Loans - Direct or FFEL

If a student and their parents fill out the Free Application for Federal Student Aid (or FAFSA), the student would potentially become eligible federal financial aid either direct from the Federal Government (called Direct Loans) or through the Federal Family Education Loan Program (FFEL). The Direct route is pretty easy to understand…you need money and the Government provides the loan directly.

The loans through FFEL are offered by private institutions but the Federal Government backs (or collateralizes) them. In essence, this is where banks are offering student loans at reasonable interest rates because they know the Federal Government will make them whole should the student or parent not repay the loan. (By the way, I’m not suggesting a student or parent should NOT repay their loan. Ultimately, the Government can take their pound of flesh if you don’t pay, including through wage garnishment…not fun! Pay your bill!)

There are a multitude of similarities between the Direct Loans and FFEL program however there are differences as well:

FFEL lenders have to provide the same interest rate for Direct Subsidized and Unsubsidized Loans but can charge a higher interest rate for Parent PLUS loans.
Criteria for approval can be more lax for Direct Loans from the Government compared to stricter criteria through FFEL lenders.
Certain repayment options are not available if you get your student loans through an FFEL lender.
Not all schools participate with FFEL lenders, however the vice versa is true as well.
Ease of the application process has a slight edge to the Direct Loan channel while ongoing servicing tends to be have a slight edge in the FFEL program.

In the end, the primary decision will be based on whether or not the student and/or parent will need loans beyond the traditional Direct loan option. If so, it will most likely be more expensive and there will potentially be less options available going down the FFEL path.

Student Loan Options 101

Direct Subsidized or Unsubsidized Federal Student Loans – sometimes referred to as Stafford Loans, these are the most common loans provided by the Federal Government. They tend to be low interest rate, are limited in the amount awarded based on whether or not the student is independent or dependent on parents, and can be used to cover the cost of four-year colleges and universities, community colleges, trade and technical schools, as well as any number of career studies such as post-graduate programs in law or medicine. The big thing to know about these is the difference between Subsidized and Unsubsidized loans. With Subsidized loans, the interest is paid by the U.S. Government as long as you are in school at least half-time and are within the grace period of six months after your schooling ends. The Government will even pay the interest during a period of deferment which is a fancy term for qualifying under any number of financial distress circumstances that allow you to defer making payments for a period of time. With Unsubsidized loans, the Government does NOT pay the interest during schooling, the grace period or periods of deferment. In other words, the interest accrues while you are in college and the amount you owe after college can be substantially higher than when you took the loans in the first place.

Why not just take out the Subsidized Loans? Unfortunately, it’s not that simple. The U.S. Government tends to drastically restrict the amount of Subsidized loans it will reward based on a number of factors including income and assets of the student and their household. It is rare for any student to cover 100% of their schooling with only Subsidized loans.

Direct PLUS Loans – sometimes referred to as Parent PLUS loans because these loans are actually taken out specifically by the parent of a student, unless the student is in graduate level studies in which case the student can take them out on their own. These loans tend to have higher interest rates and fees than regular Federal Student Loans. However, the Federal Government will award loan amounts up to the value of the education minus outstanding loans already rewarded.

This is important!! If they will only reward the amount AFTER other loans have been been rewarded, it would make a lot of sense to review other loan options and determine if they provide better terms. If not, apply for Direct Plus loans first before any other funding options and after Direct Federal Student Loans have been rewarded.

Perkins Loans – these loans are federal loans but are awarded based on the college’s discretion and are usually only awarded to students that have extreme financial need. They have low interest rates, low maximum award amounts and are administered by the college unlike the other federal loans which are administered by the Federal Government or the loan administration companies they hire to handle the loans on their behalf.

Direct Consolidation Loans – these loans are options available by the Federal Government that allow a student or parent to consolidate multiple loans together into one loan. This can provide substantial simplicity over dealing with payments to multiple loan providers, but students and parents need to be cautious about choosing this option as the interest rates could be higher for these loans than what the students and parents already have. Keep in mind that these loans will NOT allow a student or parent to consolidate a private loan…only the type of loans mentioned above.

Private Student Loans – These are the only type that do not fall under the supervision of the Office of Federal Student Aid. Most students and parents should consider these as lending of last resort because the rates tend to be higher than any of the federal programs (i.e. they are not backed by the Federal Government and therefore the banking institution is taking on the entire risk of the loan being repaid). The loans are also not regulated by U.S. Department of Education and therefor can impose any number of rules, including call features that require the loan to be repaid sooner than expected or even rates that change.

Okay…now you have an idea of the different types of student loans available and a few pros and cons of each. Remember…choosing the right combination of student loans (or even private funding without loans) requires substantial amounts of planning well in advance of college. However, even if loans have already been taken out, there are unique ways students and parents can still maximize their approach to repayment. In the next blog, we will tackle repayment options. Stay tuned!

Student Loans and Strategies to Pay Them Off (Part 1)

Andrew Silver

Federal Loans - Direct or FFEL

Student Loan Options 101

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