FAFSA Applications Opened Early! Here’s What You Need to Know About Student Loans Before You Begin

Starting October 1, current and prospective students can complete their online FAFSA form. The Free Application for Federal Student Aid, or FAFSA, determines students’ eligibility for student loans and other financial aid. Usually, the opening period begins on January 1st to allow students’ families to file their taxes. But a new rule lets applicants use prior taxes on the form.

Weeks after completing the FAFSA, students receive a reward letter  breaking down how your loans will be dispersed. This letter can be confusing to new students, as there are various types of student loans, some better than others. You do not have to accept all the aid given to you if you don’t need it.

Before you begin your FAFSA, read up on the basics of student loans in this post. This will help you decipher that reward letter and figure out which loans to keep and which to reject.

The Big Picture

There are three broad types of undergraduate student loans that you should be familiar with before you complete your FAFSA:

Federal Direct Loans: federal loans made directly by the government

Federal Loans: federal loans that are made by banks or other lenders but are guaranteed by the government

Private Loans: alternative loans from banks or other lenders which carry no guarantee (known as “private” loans).

First Choice: Federal Loans

Federal loans are your best option, because their fixed interest rates, which are always posted by the Department of Education. Federal loans also come with protections for borrowers like deferment or forbearance. These protections allow you to apply for a temporary agreement to skip or adjust your loan payments under certain circumstances. Both deferment and forbearance are a life saver for  unexpected events like a sudden layoff or serious medical condition. There are also several types of federal loans:

Stafford Loans: These are the most common federal direct loans, and are not awarded based on financial need. There are also two types of Stafford Loans: subsidized and unsubsidized. For subsidized Stafford Loans, the government pays the interest while you’re still in school. Conversely, unsubsidized Stafford Loans accrue interest while you’re in school. You’ll have to pay the interest either as the bill comes due or have it added to the principal amount.

Perkins Loans: The federal government offers these loans to students with the most financial need. The first students up for these loans are those who were also awarded Pell Grants, which are designated for low-income students.

Parental Loans for Undergraduate Students (PLUS): Parents of students can take out federal loans to cover the full “cost of attendance.” Every college has an estimated “cost of attendance,” which includes tuition, fees, room and board. The cost also leaves an allowance for books and supplies, transportation and personal expenses.

A Word of Caution: Be Careful about Extra Benefits

There are some added benefits from individual lenders that offer discounts that are hard to beat, but you’ll need to be proactive. For example, some lenders offer a reduced interest rate or a decreased principal amount if you make 36 consecutive payments on time. Benefits like this are tricky, because many – I’ll say it again, because I mean it – MANY recent graduates will miss or make a late payment. This is either because they can’t make the payment or because they’re still figuring out how to manage their loan repayment schedule. Also, if you do qualify, many people forget to ask for the benefit when it does kick in. Lenders don’t have to remind you, so be on top of it.

Second Choice: Private Loans

Private or “alternative” loans are like any other loan that you get from a bank or financial institution, and their terms vary. And I do mean WIDELY, so be sure to read all the fine print with your trusty magnifying glass. The interest rates on private loans are almost always higher than federal loan. Most private loans have variable-rates, which means that the interest can change over time.  The interest rate tends to align with federal interest rate changes and they can be dramatic. Nobody can predict the future interest rate, but the Federal Reserve sometimes drops hints about expected changes in the near future. For example, experts expect interest rates to rise next year…keep that in mind if you’re looking at paying adjustable rate loans.

Private lenders also offer fixed-rate private loans. These interest rates are usually the highest of all, because they’re less risky if you don’t have to worry about changing interest rates. So in the end, it comes down to knowing how long you expect to pay off your loan and how much risk you’re comfortable with. Many student loans come with 10-year repayment plans, which is a long time. You can pretty much expect the interest rate to change, even if you don’t know how much it will change or in which direction. Shorter-term loans leave less time to experience dramatic interest changes, making possible rate changes less impactful.

Understanding the different types of available student loans is essential to keep your future debt in control. With student debt levels surpassing $1 trillion this decade, it’s more important than ever to realize what you’re getting into. This way, you can head off problems before you even see that first repayment bill.