Graduating with student loan debt isn’t ideal, but it’s a necessity for many college students to get through school. Understanding the definitions of various student loan terms can help you make more informed decisions and potentially reduce the long-term costs associated with college debt.
Whether you’re an incoming freshman or an outgoing senior, here are some of the more common terms and what you need to know about them.
College students and their parents typically don’t have to make payments on their student loans while the student is in school, deferment or forbearance. But if you have private student loans or unsubsidized federal student loans, interest still accrues during those periods. Interest also accrues on subsidized loans during forbearance.
Once the grace period ends, the student loan servicer or lender capitalizes that interest, adding it to your principal balance and increasing how much you owe. This essentially means you’ll be paying interest on top of interest. Fortunately, it’s possible with many servicers and lenders to make interest-only payments to avoid capitalization.
If you can’t get approved for a private student loan or for student loan refinancing on your own, you may be able to improve your odds with a co-signer. A co-signer is someone who adds their name to your loan application and effectively takes responsibility for making payments if you can’t.
If someone co-signs a student loan with you, the account will show up on both of your credit reports, and missing a payment or defaulting can hurt both of your credit scores. Some private lenders offer a co-signer release program, which allows you to remove a co-signer from your loan if you meet certain payment and credit criteria.
Your debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward debt payments. For example, if your monthly salary is $5,000 and you have $1,200 in debt payments, your DTI is 24 percent. You will likely need to have a debt-to-income ratio below 50 percent in order to qualify for student loan refinancing.
If you’re applying for a mortgage, your student loan payments will be included in your back-end DTI, which includes all your debts. However, mortgage lenders will also calculate your front-end DTI, which includes only housing-related costs.
Delinquency and default
If you have private student loans, what constitutes delinquency and default can vary by lender. With federal loans, however, delinquency begins as soon as you miss a payment, and it’ll be reported to the national credit bureaus once you’ve been delinquent for 90 days or more.
Federal loan default typically occurs if you haven’t made your scheduled payments for 270 days. Once your loans are in default, the entire balance is due immediately, and you may face other consequences. Fortunately, it’s possible to bring your loans out of default and get back on a regular schedule.
The federal government offers several income-driven repayment plans, which can reduce your monthly payment to a percentage of your discretionary income. The plans also extend your repayment term by up to 25 years. If you have a balance at the end of that term, it’ll be forgiven.
Income-driven repayment plans can be a lifesaver for borrowers who are struggling to make payments. That said, private student lenders typically don’t offer them.
Interest rate and APR
The interest rate on a student loan is the percentage that student loan servicers and lenders use to calculate how much you owe on top of your outstanding student loan balance every month. The annual percentage rate (APR) is the full cost of borrowing, which includes interest, fees and other charges.
If there are no fees or other charges associated with your loan, the interest rate and APR are generally the same. If there are, the APR will be higher than the interest rate. In most cases, the rate that companies advertise is the APR. With federal loans, however, the interest rate and fees are listed separately on the Education Department’s website.
Private vs. federal student loans
Private student loans are offered by private lenders, while federal student loans are provided by the U.S. Department of Education. There are many differences between private and federal student loans.
For example, while all private loans require a credit check, most federal student loans don’t. Also, private loans generally don’t come with certain benefits, including access to income-driven repayment plans and student loan forgiveness, and their deferment and forbearance programs may not be as generous.
Federal loan interest rates are standardized and fixed, which means they’re the same for everyone who qualifies and stay the same throughout the life of the loan. With private loans, your rate depends on your creditworthiness. You may also have the choice between fixed and variable rates; if you choose a variable rate, your interest rate is subject to change.
Student loan consolidation
In general terms, debt consolidation is similar to refinancing — the process involves paying off one or more loans or credit cards with a new loan. Student loan consolidation may refer to private student loan refinancing, but it’s more commonly used to describe the federal Direct Loan Consolidation program.
This program allows borrowers to replace one or more federal student loans with one new one. Depending on the type of loans you have, Direct Loan Consolidation could help you qualify for certain repayment plans, qualify for student loan forgiveness or get your loans out of default. However, it does not allow you to get a lower interest rate as refinancing often does.
Student loan deferment vs. forbearance
Student loan deferment and forbearance both allow you to postpone payments for a predetermined period of time, but there are a few differences. If you have subsidized loans, for instance, interest will accrue during forbearance but not deferment.
Also, deferment options are typically more generous as far as who qualifies and how long you can pause your payments. Deferment and forbearance are generally offered by both federal student loan servicers and private student lenders, but eligibility requirements and terms can vary.
Student loan forgiveness
Certain student loan borrowers with federal loans may qualify for student loan forgiveness programs. There are several different ways to have some or all of your student loans forgiven, but they typically don’t apply to private loans. Most forgiveness programs are occupation-based and require years of qualifying payments prior to forgiveness. If you’ve recently graduated or you’re graduating soon, look into the various federal student loan forgiveness programs to see if you meet the application criteria.
Student loan refinancing
Student loan refinancing is the process of replacing one or more existing loans with one new one through a private lender. If you’re eligible, refinancing your loans could allow you to get a lower interest rate and monthly payment, get flexibility with your repayment schedule and choose a different lender.
Refinancing student loans isn’t for everyone, though; it can be challenging to qualify if you don’t have a strong credit history or high income, and if you refinance your federal student loans, you forfeit your federal benefits and protections.
Student loan servicer
If you have federal student loans, the money you receive is from the federal government, but your student loan servicer is the private company that manages your account and collects payments. You generally don’t get to pick your servicer when you first apply for federal student loans, but you can if you consolidate them later on.
Unsubsidized vs. subsidized loans
Federal subsidized student loans are designed for undergraduate college students who demonstrate financial need. With these loans, the federal government pays your interest while you’re in school at least half time, for the first six months after you graduate and during any future deferment periods.
Unsubsidized loans, on the other hand, function like other traditional student loans, which means that interest accrues whether or not you’re making payments, and you’re responsible for paying it.