Types of Student Loans –Conventional vs. Unconventional

Student loan application form with pen, keyboard, and text book.From tuition and books to room and board, the cost of college has skyrocketed over the last several decades. This has left many students pursuing a college education in need of some form of financial aid to help cover expenses. Fortunately, student loans are available to help when needed. Both conventional, or federal, student loans, and unconventional, or private and alternative, student loans exist in the market today. Here’s a breakdown of each, and how to choose which may work best for your education funding needs.

Federal Student Loans

The most common type of student financial aid comes in the form of federal student loans. Also known as public or conventional loans, federal student loans are funded by the Department of Education and come in two broad categories: subsidized and unsubsidized. Let’s take a closer look at each.

Subsidized Student Loans

Subsidized loans are made available to undergraduate students who have a clear financial need. These loans have more favorable terms than unsubsidized loans, mainly because the federal government pays the interest while you are in school and during a six-month grace period after graduating. Subsidized loans are limited to the following amounts each school year:

  • No more than $3,500 for first-year undergraduate students
  • No more than $4,500 for second-year students
  • No more than $7,500 for third-year and beyond students

Unsubsidized Student Loans

Unsubsidized loans are also made available through the federal government to undergraduate students, but graduate students may also qualify for this type of financing. Unsubsidized loans do not require proof of financial need, but they have less favorable terms. The Department of Education does not pay for interest while loans are deferred, meaning interest accrues from the moment funds are dispersed. This can increase the cost of borrowing for students who rely heavily on unsubsidized loans. However, higher loan amounts are available:

  • No more than $5,500 for first-year students; $9,500 for independent students
  • No more than $6,500 for second-year students; $10,500 for independent students
  • No more than $7,500 for third-year and beyond students; $12,500 for independent students

Both subsidized and unsubsidized loans come with certain advantages and federal protections for borrowers. These benefits include access to income-based repayment plan options which can lower the monthly burden of repayment after graduation.

Borrowers also have the ability to postpone payments through deferment or forbearance if financial circumstances require it. Loan forgiveness is also an option for certain borrowers, including those who work for the federal government or in public service. Interest rates on federal student loans are fixed and set by Congress, so borrowers know what they are paying in interest charges for the life of their loans.

Getting a Federal Student Loan

Applying for federal student loans requires completing the Free Application for Federal Student Aid, or the FAFSA. The process does not require an in-depth credit check, nor do borrowers have to make a certain amount of income each year to qualify. However, federal student loans are limited in terms of how much can be borrowed each school year, making additional or alternative loans a necessity for many.

Private Student Loans

Also known as unconventional loans, private student loans are another option for students, particularly those who have exhausted federal student loan funding. Private student loans are available through a handful of private lenders, including online student loan providers, banks, and credit unions. Each has its own requirements for qualifying as well as loan limits, but generally speaking, here are a few characteristics of private loans:

  • Borrowers need to have a high credit score and clean credit history to qualify
  • Some lenders allow for co-signers to be added to a loan to strengthen the potential for approval
  • Repayment options do not include income-based programs or student loan forgiveness
  • Student loan amounts can be up to the total cost of attendance for accredited colleges and universities
  • Interest rates may be lower than federal student loans
  • Borrowers can choose from fixed or variable interest rates
  • Repayment terms as short as five years or as long as 25

Private student loans may be beneficial for students who need more financing than what federal loans can offer. However, it is essential to note that if student loans are necessary, federal loans are most often the best place to start. Private student loans do not offer the same protections to student borrowers as public loans, making them more challenging to manage should repayment become an issue in the future.

Alternative Loan Options

In addition to federal and private student loans, some universities and colleges around the country are turning toward alternative financing options for students. Income share agreements are a form of borrowing for education costs that are ultimately tied to a borrower’s earnings. Instead of setting a repayment scheduled based on the total amount borrowed and a fixed or variable interest rate, income share agreements calculate payments as a percentage of earned income. The repayment terms are set at that percentage for a known period of time, such as ten or 15 years.

This has the potential to drastically lower the total amount repaid over time for lower-income graduates; however, high-income earners may pay far more in the long run with income share agreements.

Final Thoughts on Conventional and Unconventional Student Loans

Students who are pursuing a college education have a bevy of options when it comes to financing a degree. Federal student loans should be the first line of defense, given the inherent benefits they provide to student borrowers. Private student loans can be used to fill in gaps in funding, but students need to be aware they have less flexibility with repayment down the line. Finally, students can check with their college or university to see if alternative financing options like income share agreements are available.

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Posted on December 18, 2020 by in Student Loans

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