College Freshman, College Hacks, Finance

Crash Course 101: College Debt and How it Works

This is a Guest Post Written By Regan Hamilton (Follow Her On Instagram @reganhammy10)


In order to combat student loans, most students will use the government-backed financial plan the Free Application for Federal Student Aid, or FAFSA. For those who don’t know, FAFSA is an online form students fill out every year in order to receive certain loans from the government.

If you are in college, thinking about going to college, or recently graduated, there is no doubt that you have heard the words student debt and that it is a scary thing.

But what exactly makes it so scary?

Over the past years, the price of college has been increasing faster than goods and services, and because of this, the government has stepped in to ensure students can still afford to attend college. 

Because FAFSA comes as a first-come-first-serve basis, when it comes to filling it out, it helps to do it sooner rather than later. There are many different types of loans FAFSA includes, such as the Stafford, PLUS loans, and Perkins, but what is more important is whether these loans are subsidized or unsubsidized. 

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Subsidized or Unsubsidized? 

Subsidized means that the borrower (the student) will not pay an interest rate on the loan, but for an unsubsidized loan, interest rates will apply. 

However, unsubsidized loans are more common, meaning that the student will have to pay additional money in interest just for taking out the loan.

Although the government does provide options in order to help students, the rising costs and the interest rates keep the price of the loans high.

Before looking deeper into interest rates, it is helpful to note that in terms of college loans interest rates, the student will want them to be lower because the lower the interest rate, the less money the student must payback. 

For example, the current interest rate for FAFSA loans is 4.53 percent interest every year, however, the interest rate for those no longer enrolled in classes is 6.08 percent every year. FAFSA understands that some students are not financially stable to pay off their student loans during their college years, so in turn the government keeps a lower interest rate, however the interest jumps up by 1.34 once undergraduate college is over. 

So why is this such a big deal? 

The slight change in interest rate, even by just a couple decimals, can lead to huge changes in the amount of money to pay back because when dealing with compounded interest, or interest that builds on itself year after year, the debt can slowly stack up.

So when dealing with a change of 1.34 percent being added to the original interest rate, this can be a decent lump of money that the student will need to eventually payback. 

For example, if the student takes out a loan for $20,770 dollars for one year of school (which is the average price for an in-state public school) and assuming this same loan would be taken out all four years and no increase in tuition, by the end of the four years the total loan bill would be equivalent to 128,827, instead of 83,080 for a subsidized loan.

Even just two years out of college, the total amount due would be 144,969 (excluding any payments made).

Some think that to calculate interest rates all you have to do is to take the loan amount (in our case 83,080) and multiply it by 1 plus the percent interest, but it is more complicated than that since student loans compound (meaning they gain the interest every year). 

Because of this, the equation we use to calculate the total loan bill is x(1+r)^2. 

The variable “x” would be the original amount of money being loaned, and the variable “r” is the percent of interest the loan receives (in our case .0453). While still in college, the x will change every year, as the cost of tuition for that year will be added on. 

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For some students, their monthly payments after college are so low that they are not even paying off this interest that is gathering every year, so the debt continues to grow despite them making payments.

Although this is a scary fact, it primarily happens because the payment plan is too lengthy or the interest rate from a private loan company is too high. Even today, there are millions of Americans that are in default, meaning the student or payer did not pay their loans for nine months, because of their lofty loans.

This means the government or lender will be entitled to up to 15 percent of the borrower’s wage, Social Security Benefits, and tax benefits.

So, what is the best way to ensure these problems do not happen to you?

The best way to combat this is to budget well during undergraduate and after graduating in order to make higher loan payments to avoid growing loans due to interest rates. 

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Another way to decrease the loan amount is, if you have the financial ability, to pay back some of the student loans while the interest rate is still at 4.53 percent, the lower interest rate offered, which saves you money in the longer run. Although this is not an option for everyone, it is crucial to avoid entering default. Most students feel as if they do not have a choice with their growing loans, but although there is no apparent solution, budgeting well and cutting out non-necessities will help you in the long run, because if a student enters into default, they will never have financial control. 

Because growing loans is becoming a pressing problem in America, some companies have gone the extra mile and created “loan forgiveness programs.” These programs, which are primarily available only in the public sector, will essentially relieve the payer of their loans after making ten years of on-time payments. 

Although this can be a good thing for some if the career path you are entering into does not have a loan forgiveness program it is best to choose the ten-year payment plan over the twenty-year payment plan, as once again, interests rates will work heavily against you over the course of these ten years.

College debt and loans can be a scary thing to think about but being informed can be the first step to managing them in the future. Being aware of the problem and knowing exactly what situation you will be in will give you the ability to make the best possible plan for student loans in the future.

 

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