Borrowing Wisely

Borrow Only What You Need

It’s tempting to borrow extra money, just in case. But keep in mind that loans are not free. You’ll need to pay back everything you borrow, plus interest. When you’re determining how much money you want to borrow, plan to have it pay only educational expenses – not entertainment and lifestyle choices. Your loan agreement will likely require you to do this, too.

Before you borrow money, consider your anticipated income and living expenses after graduation, so you can predict what you’ll be able to afford in monthly loan payments.

Understand the Basics

There’s more to borrowing money than just signing on the dotted line. The extent to which you understand the cost and subtle intricacies of borrowing will affect your ability to effectively manage your debt.

One thing that’s helpful is to be familiar with common terms associated with borrowing:

  • Principal – amount of money the lender loans to you
  • Interest – additional amount that you pay to the lender for the privilege of using the money they are lending you
  • Capitalization – process of adding accrued interest to the principal amount owed
  • Accrue – accumulation of interest

Remember, the total amount you owe on your loan is much higher than the amount you receive because of the interest. For example, if you borrow $10,000 at an interest rate of 8.25%, your payments may look something like this:

Loan amount: $10,000
Interest rate: 8.25%
Repayment period: 10 years
Number of payments: 120
Each payment: $122.65
Total amount repaid: $14,718

Making Payments

Note: This section does not apply to Stafford Loans

Another important point to remember about borrowing is that loans are structured to put most of your initial payments toward the interest you owe, rather than toward repaying the principal.

For example, suppose you decide to pay off a loan after you’ve been making payments for three years. You may be surprised to find out that your principal has not been reduced as much as you thought because the majority of your payments over those first three years went to pay off the interest portion of the loan, not the principal.

With revolving credit such as a credit card, the picture can be even more dramatic. If you have a high enough balance and make low enough payments, you may not be repaying the principal at all. In that case, your debt will just continue to increase.

Let’s say that you have a $5,000 balance at a 17% interest rate. If you paid $100 a month for 36 months, your new balance should be approximately $1,400. Instead, due to the structure of most credit-based loans, your monthly payment is applied toward the interest first. That means out of the $3,600 you paid, only $1,346 went toward the principal. In reality, you still owe $3,654. And if you continue paying $100 each month, it would take seven-and-a-half years to pay off the $5,000, and with interest you’d have paid a total of $8,819.

TIP: Be sure to make loan payments as scheduled or you may be charged late fees and collection costs

Loan Consolidation Overview

A Consolidation Loan is designed to help student and parent borrowers simplify loan repayment by allowing the borrower to combine several types of federal student loans with various repayment schedules into one loan. You can even consolidate just one loan into a Direct Consolidation Loan, in order to get benefits such as flexible repayment options. If you have more than one loan, a Consolidation Loan simplifies the repayment process because you make only one payment a month. Also, the interest rate on the Consolidation Loan might be lower than what you’re currently paying on one or more of your loans.

Both the Direct Loan Program and the FFEL Program offer Consolidation Loans. Direct Consolidation Loans are available from the U.S. Department of Education. FFEL Consolidation Loans are available from participating lenders such as banks, credit unions, and savings and loan associations.

Plus Loan Overview

PLUS Loans enable parents who do not have an adverse credit history to borrow to pay the education expenses of each child who is a dependent undergraduate student enrolled at least half time. PLUS Loans are available through both the Direct Loan and FFEL programs. Most of the benefits to parent borrowers are identical in the two programs.

The yearly limit on a PLUS Loan is equal to your cost of attendance minus any other financial aid you receive. For example, if your cost of attendance is $6,000 and you receive $4,000 in other financial aid, your parents could borrow up to-but no more than-$2,000.

The interest rate could change each year of repayment, but, by law, it will never exceed 9 percent. The interest rate for PLUS Loans in repayment from July 1, 2001 to June 30, 2002, was calculated at 6.79 percent. The interest rate is adjusted each year on July 1. Interest is charged on the loan from the date that the first disbursement is made until the loan is paid in full.

Federal Plus Loan capsule:

  • Available to parents of undergraduate students.
  • As noted above, parents must be credit worthy.
  • Parents have up to 10 years to repay.
  • Payments usually begin after the first disbursement.
  • The variable interest rate is capped at 9.00%
  • Parents can borrow up to the Cost of Attendance minus any financial aid, including other loans received.

Perkins Loan Overview

The amount of the loan is determined by each college and is based on the expected family contribution.  The student will be held responsible for this loan, not the parent. Repayment doesn’t begin until after a student graduates, falls below half-time student status, or leaves college.  After graduating, a student typically has a nine-month grace period during which interest doesn’t accrue.  Perkins loans offer low interest rates to students and can be repaid within ten years.  A need-based, low-interest loan available to students rather than their parents.  The amount of the loan is determined by each college and is based on the expected family contribution.  The student will be held responsible for this loan, not the parent.

Federal Perkins Loan basics:

  • Maximum loan is $3,000 per year, average of $1,000
  • No interset charged while enrolled at least half time.
  • Loan is available to needy undergraduate and graduate students.
  • Interest rate of 5% fixed.
  • Payment begins nine months after graduation or you are enrolled less than half time.

Stafford Loan Overview

Stafford Loans are a major form of self-help aid for students. Depending on the school you attend, your Stafford Loans may be made either through the Direct Loan Program or through the FFEL Program.

If you’re a dependent undergraduate student you can borrow annually up to

  • $2,625 if you’re a first-year student enrolled in a program of study that is at least a full academic year.
  • $3,500 if you’ve completed your first year of study and the remainder of your program is at least a full academic year.
  • $5,500 if you’ve completed two years of study and the remainder of your program is at least a full academic year.

If you’re an independent undergraduate student or a dependent student whose parents are unable to get a PLUS Loan, you can borrow annually up to

  • $6,625 if you’re a first-year student enrolled in a program of study that is at least a full academic year (only $2,625 of this amount may be in subsidized loans).
  • $7,500 if you’ve completed your first year of study and the remainder of your program is at least a full academic year (only $3,500 of this amount may be in subsidized loans).
  • $10,500 if you’ve completed two years of study and the remainder of your program is at least a full academic year (only $5,500 of this amount may be in subsidized loans).

If you’re a graduate or professional student:

  • For graduate and professional students, the combined annual loan limit for subsidized and unsubsidized Federal Stafford Loans is $18,500 ($8,500 can be subsidized loans). The maximum for the subsidized Federal Stafford loan is $65,500. The maximum for a combination of both unsubsidized and subsidized Federal Stafford loans is $138,500.

Additional rules covering Federal Stafford Loans:

  • Interest rates are capped at 8.25%
  • You have up to 25 years to repay, although 10 years is the norm.
  • Payment begins 6 months after you graduate or are enroled on less than a half time basis.