An Overview of Student Loans

Updated: Dec 1, 2019

History of Student Loans

Federal student loans were not introduced until the 20th century. Before then, government and philanthropists funded most education costs since students went to college to become teachers, government employees, ministers and other professions deemed as “public service.” The costs that were not covered by the government, such as room and board, were covered by the students - which limited college financial accessibility to the affluent.

After World War II, the government had to create programs that would reintegrate veterans back into American society. The 1944 GI Bill was enacted and paid for veterans’ college tuition and student housing. This was the first time the government created a program that provided financial assistance to working class college students. As a result, college enrollment rapidly increased and the need for additional forms of government financial assistance for college students became necessary.

In 1958, the National Defense Education Act provided federal funding to grade schools and universities to educate young people in areas that would make our country more competitive in the Cold War against Russia. This funding trickled down to college students in the form of student loans. It was this Act that introduced most middle class Americans to student loans and served as a precursor to the massive debt our students incur present day.

Free Application For Student Aid (FAFSA)

In 1992, the Federal Application for Student Aid (FAFSA) process was implemented to streamline the distribution of loans to students who had the greatest financial need.

Students in need of college financial aid were and still are required to complete the FAFSA. The FAFSA is reviewed by counselors to determine a student’s Expected Family Contribution (EFC). To calculate a student’s EFC, a formula is used that includes the parent’s income and assets, family size, number of siblings in college and other factors. The EFC is deducted from the cost of attendance to determine a student’s financial need.

Private Student Loans

The FAFSA, however, does not determine private loan eligibility. Middle Class students who come from households with income too high to qualify for full federal aid, but have savings too low to pay for college costs out of pocket often have to consider private student loans.

These types of loans are mostly distributed by banks. Most personal finance experts would warn not to take out private student loans because of the variable or high interest rates attached to them. In addition, unlike federal student loans, good credit is required to obtain a private student loan. Loan forbearance and forgiveness are also not always an option with private loans.

Refinancing Student Loans

Refinancing student loans is taking out a new loan, ideally at a lower interest rate, to pay off remaining student loans. A refinanced student loan will combine federal and private student loans into one payment. Companies that refinance student loans are private companies, therefore, refinanced loans are not eligible for federal student loan forgiveness or flexible federal repayment plans.

The interest rate on refinanced student loans is dependent on a loan holder’s credit score. For a person fresh out of college with little to no credit, refinanced loans might not offer a lower overall interest rate. This type of loan might better suit someone employed with a fixed income and good credit.

Consolidating Student Loans

Federal student loans can be consolidated into one single payment. The overall amount due will not decrease, in fact, the amount due might actually increase since certain loans will be spread out over a longer period and require a loan holder to pay more in interest over the long run.

Federal student loan consolidation is a good option for those that might struggle with making multiple payments on multiple federal loans. The loans can be consolidated via the government’s Direct Loan Consolidation Program. The program will combine loans into one loan with a fixed interest rate based on the average of the interest rates on the loans being consolidated.

Deferment, Forbearance, and Delinquency

For those that struggle to make student loan payments, the federal government offers several options to temporarily relieve the amount due. Student loan deferment provides the option to pause student loan payments for a maximum of 36 months. To qualify for student loan deferment, a loan holder must submit an application demonstrating economic hardship, in-school deferment, unemployment disability, and other eligible purposes for deferment.

Student loan forbearance is available to those who do not qualify for student loan forbearance. In forbearance, a loan holder can lower or postpone loan payments for 12 months at a time. It is important for a loan holder to note that, in deferment and forbearance, unsubsidized loans will continue to accrue interest. If interest payments are not made during deferment and forbearance periods, the interest will compound and the overall loan payment will increase.

Unpaid student loans that are not in deferment or forbearance are delinquent and will fall into default. Defaulted student loans are dangerous to a loan holder’s credit and financial stability. In default, the amount due will be reported to all three credit bureaus, tax refunds might be withheld, wages might be garnished, collection fees might be incurred, and credit score will be negatively impacted. If you find you are unable to pay your student loans, contact your loan provider immediately to discuss your options.

Student loans can be a great investment. The key is to make sure you stay on top of your payments to get the most out of what you have invested.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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