Education Loan: Definition, Types, Debt Strategies

An education loan is designed for students to pay for college or university-level studies. Post-secondary education can be costly, irrespective of the field in which you are trying to graduate.

Education loans are helpful in that regard. Banks, the government, and financial institutions provide these types of loans. They are expected to cover your overall expenses relating to the studies, whether tuition fees for your college or any costs for books, notebooks, pens, or other essentials.

Sometimes, they also cover your living expenses if you are studying abroad or far from home. Student loans are preferred because of their low interest rates and flexible payment system.

There is a grace period between your graduation and employment, which usually lasts around six months. After you land a job, the repayment of the loan starts.

Education loans can be divided based on various parameters, such as sponsorship, collateral, location, or courses. Two of the most common types are federal loans and private loans.

Likewise, the loan structure varies if you study at a university in the country or overseas. It will also differ from the courses you are trying to apply for. 

Undergraduate courses usually last 3-4 years, while the post-graduation loan period lasts around two years and six months. 

You can also apply for loans for your career development studies, and interest rates can be cheaper than graduation loans.

Federal Student Loans

Federal loans are usually the first choice for any student seeking a loan. They offer low interest rates and flexible repayment options compared to private loans.

The repayment for federal loans can be deferred during their college days. Following graduation, there are options for income-driven repayment plans and loan forgiveness.

How are they approved?

1. Submit a Free Application for Federal Student Aid (FAFSA) form.
2. You will have to list the college or institution you are applying for, and the loan amount is determined based on the courses, university, and cost of attendance.
3. Once approved, the institution will review the application and work on the financial aid package you qualify for.
4. Finally, the college/institution will send you a financial aid offer that may include the loans you applied for.

Before applying for the loan, the US government will conduct mandatory entrance counseling to ensure you understand your obligation to repay. Likewise, you will also have to agree on the Master Promissory Note regarding the loan terms.

Subsidized Loans

Subsidized loans are distributed based on financial need. Students from low-income backgrounds or those struggling to afford higher studies can apply for subsidized loans.

These loans are only available for eligible undergraduate students. The US government pays some of the interest under certain conditions, including your college time and grace period.

Unsubsidized Loans

Unsubsidized loans are not based on financial need; eligible undergraduate, graduate, and professional students can apply for this type of loan. The interest rates can be higher, and the students are responsible for paying the interest.

Parent PLUS loans

If parents borrow money for their dependent undergraduate students, it is called a Parent Plus or Direct Plus loan. Graduate or professional students can also apply.

Consolidation loans

Consolidation loans are a single loan service after combining all eligible federal loan plans. You might be approved for multiple federal loan plans; consolidation will give you the best package possible.

Private Student Loans

Private lenders like banks, credit unions, or any other financial institution can help students cover the cost of their education as financial aid. The terms and conditions may vary with the lender.

These loans are not flexible and cheaper than federal loans but can be a good option for students seeking higher education. Usually, the borrower's income source and credit score or history determine the eligibility.

Sometimes, a parent or guardian as a co-signer is needed.

Federal loans are better than private student loans, considering the security and overall payment plans.

• The interest rate on federal student loans is cheaper than private loans.
• A particular portion of federal student loans can be forgiven upon meeting conditions.
• Flexible repayment plans and the option to defer until your grace period.
• No credit check or co-signer is needed to apply for federal loans.
• If you are applying for a subsidized loan, the US government will also pay some of your interest.

Student loans can seem an elusive option if you are planning to pursue higher education and have a confined budget, but remember that it's a debt you must pay in the future.

So, before applying for a loan, you must consider how much you need to borrow and how much you can comfortably afford to pay back.

Here are the 7 guidelines you should consider before taking out an education loan:

1. Explore alternatives like scholarships, grants, and sponsorships before applying for an educational loan because you do not need to repay them. 
2. If you must apply, go for a federal education loan before taking out a private loan.
3. Borrow only what you need and what you can pay in the future.
4. Student loans can only be used for education-related expenses. So, make sure you use it efficiently.
5. Be careful while estimating future income because graduation will open doors, but it does not guarantee you will find treasures.
6. Student loans will be reflected on your credit score. So, make sure you can manage that debt in the future.
7. Always be in contact with your servicer and up to date on interests so you will not have to bear fines.

Education Loan is a significant financial burden for many students and graduates, especially for those who have just started their careers. You do not need to panic because the debt can be managed appropriately with a clear strategy.

Here are some of the ideas for effective management of education loans:

1. Track your total debt and plan

As long as you know how much you owe in student loans, you can plan how to repay them or devise strategies and timelines for repayment.

2. Explore loan forgiveness options

If you are in debt from a federal education loan, ensure you have explored all the forgiveness options available. Likewise, other possible scenarios of forgiveness may include working as a public service provider, teacher, and so on.

Sometimes, if an institution closes before graduation or you are physically disabled, forgiveness can be an option.

3. Debt Avalanche strategy

Your principal amount will decrease if you pay more than what's due monthly. As a result, interest amounts will also be saved.

For example, paying $20 extra monthly on a $20,000 (20 months) student loan allows you to retire the loan earlier and save more than $1000 in interest.

4. Pay down principal

While paying interest, add as much principal amount as possible so that your interest amount will decrease every month.

5. Pay high interest first

If you have multiple loans, prioritize the ones with higher interest rates first. That doesn't mean you should neglect the others because fines might be hefty.

6. Check if alternative repayment plans are available

Sometimes, there are options for repayment through alternative methods. Some can be Pay-as-you-earn (PAYE), Income-contingent repayment (ICR), or extended and graduated repayment modules.

7. Automatic payment

Federal and private loan providers have an autopayment option, reducing your interest rates. That way, your monthly debt will be paid automatically through your account. This will also ensure that you will not miss any payments leading to fines.

8. Refinancing or Consolidation

This will be effective if you have multiple education loans or loans from various sources. Consolidation will combine all your loans into a single service, minimizing your interest rate.

Keep in mind that the repayment amount per month will increase with consolidation. This is not feasible if you are a recent graduate and don't have a steady flow of income yet.

Content Sources:

Federal Student Aid, US Department of Education

Consumer Financial Protection Bureau US Government

Student Aid Government - How To Apply

Ameriprise Financial Services