If you are heading off to college soon, and you’re like the majority of incoming college freshmen in America, you will have taken out just over $25,000 in loans by the time you graduate. Waiting until you’re tossing your cap in the air to think about what you’ve gotten yourself into is not a good idea. Arm yourself with a knowledge of these basic financial terms before you sign off on a loan.
- Default: This is the absolute number one term to learn when it comes to student loans. If you are unable or unwilling to pay back your loan, the IRS can intercept your tax refunds, the lender can help themselves to part of your paycheck, and you can be sued.
- Delinquent: Remember being a juvenile delinquent? Being delinquent on a loan means you’ve messed up, only you’re not a kid anymore. When you miss a loan payment you become delinquent, and you open yourself up to problems like bad credit reports down the road.
- Promissory note: The contract that a borrower signs as a promise to pay loan money back is a promissory note. Student loans involve this kind of note. It’s a legal, binding document, so read it carefully.
- Monthly payment: Not to insult your intelligence, but this is what you owe the lender every month. Some student loans have a minimum payment, but you should consider paying more if you can. Use a student loan calculator to see what the payments would be before approaching the lender.
- Interest rate: Unlike federal loans that have a locked-in interest rate, private student loans have variable rates. These rates rise or fall based on the “prime rate” (currently 3.25% in the U.S.) that is updated quarterly, although it hasn’t changed since March 2009.
- APR: When shopping for a student loan, you should use the annual percentage rate to compare options, not the base interest rate. The APR factors in the interest rate, fees, deferment options, and interest capitalization.
- Deferment: There are a few scenarios where lenders will allow you to temporarily stop making payments on your loan. These may include economic hardship, unemployment, internship, and military deployment.
- Forbearance: If you can’t get a deferment on your loan, you may still be able to work something out with the lender. A forbearance could involve smaller payments or extended time to make them.
- Grace period: Some loans come with a short window of time after graduation in which you are not required to make monthly payments. Stafford and Perkins loans come with grace periods of six months and nine months, respectively.
- Capitalization: On an unsubsidized loan, interest begins to accrue the day the deferment period is over. This amount is added to the principal (see #19). That amount then also accrues interest. Fun, no?
- Subsidized: If you can prove financial need, you may be able to secure a sweet subsidized loan like a Perkins loan (see #25). With this type of loan the interest does not accrue while you are at least a part-time student.
- Repayment options: With some loans you can change the way you pay them back after getting them. The standard repayment plan is a minimum of five years and a maximum of 10 years in which to pay off your loan.
- Extended repayment: If you are afraid of defaulting, switch to an extended plan to extend the life of the note and lower the payments. Bear in mind that you will end up paying far more in the long run because of the interest.
- Graduated repayment: If you land a good job soon after graduation, switch to a graduated plan that will increase your payments over time, usually around every two years. Use a loan calculator to see just how much you’ll save by paying it off faster.
- Consolidation: A way to manage your debt and simplify paying off your loans is to consolidate them. However, federal loans cannot be consolidated with private ones. If you can afford your monthly payments, don’t bother with consolidating them.
- Disbursement fee: One in four banks hide fees from customers, so don’t get blindsided. Disbursement fees are fees added to the principal when the loan is granted, meaning it gathers interest.
- Origination fee: Like shipping and handling for banks, this is the fee the lender charges you to cover the cost of processing your loan. Most loans have these, including federal loans, so factor them in to the total cost of the loan.
- Repayment fee: This fee is usually based on the principal amount and kicks in when the repayment period starts. Owners of weak credit scores may be dinged with higher repayment fees.
- Principal: This is the base amount of the loan. Defaulting on a loan is so terrible because the lender will take what payments you are able to make and apply it first to interest and fees, and principal last. You have to pay off the principal to make progress toward paying off your loan.
- Borrower benefits: Also known as borrower incentives, these include principal reductions (good), interest rate reductions (better), and waiver of final payments (best). Shop around to find the best benefits you can get.
- Entrance counseling: Many lenders require student borrowers to take a small tutorial to ensure they know the terms of their loans and the consequences of delinquency and default. Usually this can be done online, but we highly recommend you take the course seriously.
- Exit counseling: Exit counseling is a lot like entrance counseling only it’s federally mandated, meaning you will be taking it if you took out a loan in college. Skip it and you may be barred from walking the stage and getting your diploma until you finish it.
- Discharge: If worst comes to worst, you may be able to get out of a student loan by declaring bankruptcy. Even then, you will have to prove continuing to pay off the note is causing undue hardship on you, a tricky proposition.
- Stafford loan: This is a low-interest loan from Uncle Sam that can be subsidized or unsubsidized. To secure a subbed loan you must prove financial need. For undergrads the interest rate is fixed at 3.4%. Sorry, grad students: yours is 6.8%.
- Perkins loan: Perkins is another federal loan with a slightly higher interest rate (5%) that is designed for students with “exceptional” financial need. It is considered the best federal student loan and it is subsidized.
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