College Graduation is quickly approaching and many students are likely beginning to wonder what is going to happen with their student loans.
When we talk about student loans they can be broken down into the most common overall types, federal loans and private loans. While both are loans there are many differences between federal and private student loans and it’s important to know what you have.
When is the first payment due?
Federal student loans generally have a 6 month grace period from the date you graduate until your first loan payment is required.
Private student loans aren’t required to have a grace period, so every lender has a different repayment term. Some lenders may require a payment immediately, while others may give you a 6 month grace period. It’s very important that you check with your lender to clarify when your first payment is due as you don’t want to miss this payment.
If I have a grace period should I start making payments now or wait?
The answer to this question depends on your individual situation. Some things to consider that may help answer this question are the following:
Do you have an emergency fund?
If you don’t - you can use this time to establish one.
Do you currently have a job?
If you do, and you have an emergency fund can you afford the payments on your current income?
How do I know what payment plan to select?
Federal student loans offer many different repayment options from the standard 10 year repayment plan (this is the plan you will be in if you don’t elect something else), graduated repayment plan, extended repayment plan, Income Based Repayment (IBR), PAYE, REPAYE, and Income Contingent Repayment (ICR).
As you can see, there are many different repayment plans available and each student loan borrower needs to evaluate their individual situation to determine their best option.
Some things to consider when selecting your plan include:
What is your current loan balance?
Do you want to pay your loan off or are you going for loan forgiveness?
Do you work for a non-profit or government organization?
Are your loans and employment status eligible for Public Service Loan Forgiveness (PSLF)?
How much of a monthly payment can you afford?
Do you expect your income to increase significantly in the years to come?
Do you have private student loans in addition to your federal loans?
Please be advised that if you call your loan provider to ask for guidance you need to be aware that they don’t know your personal financial situation and they aren’t equipped to provide you with an answer for your particular needs. This can result in misguided information in many cases.
Private student loans usually don’t have many repayment options available. They do sometimes offer extended repayment options such as a 15 year repayment plan instead of the standard 10 year repayment.
Generally your payment under the standard repayment plan is 1% of your outstanding loan balance on the day your loan goes into repayment. For example, if your loan balance is $100,000 your monthly payment will be $1,000.
How does interest accrue?
Federal student loans calculate interest using simple interest. This means that your monthly interest payment is calculated as a percentage of your principal balance.
If your interest rate is 5% and your loan balance is $100,000 you are paying $13.6986 in interest every day. (5%/365 days x $100,000).
Private student loans calculate interest using either simple interest (as illustrated in the above example) or compounded interest. Compounded interest is calculated as a percentage of your principal and accrued interest. See below for an example of compounding interest.
If your interest rate is 5% and your loan balance is $100,000 your daily interest being accrued increases every day until a payment is made. While day to day this increase may not seem like much it adds up over time.
Day 1 - Interest is $13.6986 (5%/365 days x $100,000)
Day 2 - Interest is $13.7005 (5%/365 days x $100,013.6986)
Day 3 - Interest is $13,7024 (5%/365 days x $100,027.3991)
Student loans are a very complex topic and there are many different scenarios that need to be considered. If you’re a parent and are wondering how you can help your soon to be college graduate we offer a specialized student loan analysis that can be given as a graduation gift. If you need help understanding your loans and determining a plan of action for them we are here to help.