How to Pick a Student Loan For College | What You Need to Know

How to Choose a Student Loan for College

As a college student, you must know that in order to commit to a degree program, you will need to make a substantial financial investment. Even though many undergraduate students work while they study, financial aid is still needed by the majority. But with so many options and warnings to be attentive to, it’s hard to know how to choose a student loan.

Don’t believe that federal and private loans are part of the American educational system? Well, according to EducationData, 43.4 million students currently have federal student loan debt and, in total, owe $1.747 trillion.

The student loan crisis is real, but you can avoid it. You only need to understand how they work and recognize which factors you need to take into account before applying for one.

Here at Gradehacker, we know how necessary financial aid is. Federal student loans can cover your college costs, but if you are not careful with the repayment terms and interest rates, an initially low loan could grow into an unpayable debt.

We want you to skip all possible problems and end your college experience without a massive debt. That’s why we are sharing how to choose a student loan and giving you the best tips on what to have in mind when searching for one.

How to Choose a Student Loan for College

Types of Student Loans

The first thing every student needs to understand is which type of loan you can find. These can be:

  • Federal Student Loans: You borrow money from the government
  • Private Student Loans: You borrow money from private lenders, such as banks, private organizations, and credit unions

As each type of student loan is given by a different entity, what you get from them and how can be significantly different for each one.

Let’s see them a bit more in-depth.

Federal Loans

The U.S. Department of Education sets the terms and conditions. While the interest rates are fixed and usually aren’t too high, the amount of money you can get is fewer and more limited by your academic status.

However, it’s easier to access them, and they offer a better and more extended repayment period.

Types of Federal Loans

There are three types of direct loans:

Subsidized Loans

These are for students that have demonstrated financial need. They don’t accrue interest while you are in school or during deferment periods. Plus, their repayment plan starts six months after you graduate.

Unsubsidized Loans

Aren’t based on financial need. The loan depends on your attendance cost and the financial aid you can receive. The fixed interest is charged at all times (even during deferment periods), and you can start the repayment plan six months after you graduate.

Plus Loans

They are unsubsidized loans for professional or graduate students and parents of dependent undergraduates. It’s credit-based; hence its interest rates tend to be higher than other federal loan options.

How Much Can You Borrow From a Federal Student Loan?

The limit to how much you can get from a federal student loan depends on what you fill in your Free Application for Federal Student Aid (FAFSA) application form.

You’ll include your personal information in this form, such as your financial situation. Then you’ll receive an Expected Family Contribution (EFC), which determines how much you and your family can expect to pay for the following year in college tuition.

If you want more information on FAFSA, here is everything you should know!

They will determine how much and which type of loans you can receive based on:

  • Your financial need
  • Your degree level (undergraduate or graduate)
  • The year of school you are enrolled
  • Your dependency status (whether you receive financial aid from your parents or not)

But how much is the annual loan limit according to the U.S. Department of Education?

Dependent students and people whose parents can’t obtain Plus Loans

  • First-Year Undergraduate: $5,500 (up to $3,500 subsidized)
  • Second-Year Undergraduate: up to $6,500 (up to $4,500 subsidized)
  • Third Year and Beyond Undergraduate: up to $7,500 (up to $5,500 subsidized)
  • Graduate or Professional Student: Not Applicable

Independent Students and dependent undergraduate students whose parents can’t obtain Plus Loans:

  • First-Year Undergraduate: $9,500 (up to $3,500 subsidized)
  • Second-Year Undergraduate: $10,500 (up to $4,500 subsidized)
  • Third Year and Beyond Undergraduate: $12,500 (up to $5,500 subsidized)
  • Graduate or Professional Student: $20,500 (unsubsidized only)

Now, why are Plus loans not included here?

Because they are credit-based, which means you can borrow as much as you need to cover the cost of attendance fully.

How to Choose a Student Loan for College

Private Loans

Unlike Federal loans, the terms and conditions depend entirely on the private lender you choose. Still, private student loan interests are usually higher and begin their repayment plan during the academic journey, not six months after graduation.

They also offer variable rates, which can sometimes be better, and allow you to borrow much more money.

How Much Can You Borrow From a Private Student Loan?

How much you can borrow is up to the private lender you use. The more you can prove you’ll be able to pay the money back, the more money you’ll be able to access.

To prove your background, private lenders may require you to include personal information like:

  • Credit score
  • Employment history
  • Degree type you want
  • Total cost of attendance
  • Credit score and employment history of a co-signer

How much you’ll be able to get from the entity depends on them. However, some of the most popular lenders cover the total costs of attendance (minus financial aid), with most of them borrowing between $100,000 and $200,000, and others even lending up to $500,000.

Still, be mindful that it will always depend on the private organization you are asking.

How to Choose a Student Loan for College

What You Need to Consider

Now that you know what each loan type has to offer, let’s see what you need to consider before choosing which is the right choice for you.

Interest Rates

The interest rate is the most important aspect you need to have in mind before applying for a student loan. After all, this is what can make an initially payable loan turn into a huge debt.

But don’t get too scared, because if you pay attention, you can understand perfectly how they work.

There are two types of rates:

  • Fixed interest rate: the initial interest rate will be fixed throughout the entire duration of the loan
  • Variable interest rate: the initial interest rate can increase or decrease throughout the loan term

While Federal Loan Rates are usually fixed, private student loan lenders offer both options. Your choice will define how much interest will be added to the total amount.

Repayment Options

Repayment options set how and when you will start repaying your loan.

If you choose to begin your repayment plan while you are still studying, you’ll start the monthly payment sooner, but this will reduce the overall cost, as you are paying down the interest earlier.

On the other hand, you can choose a student loan repayment plan that starts after you finish school. You’ll have fewer borrowing costs while studying, but you’ll have to pay more once you have graduated. The good news is that you have six months to find a job that helps you repay what you owe.

Repayment Terms

Finally, you need to take into account the repayment terms, which is the amount of time you’ll have to repay the total loan plus the interest.

A shorter repayment term, like a five years plan, will result in a lower overall total cost, but you’ll also have to pay a higher monthly loan payment.

On the contrary, choosing a longer repayment plan, like a 10-year term, will let you pay less for each monthly payment, but the final total loan will be more expensive.

How to Choose a Student Loan for College

How To Calculate The Interest Rate

With those key considerations explained, we can now jump to answer the most important question: How to calculate your future student loan interest rate?

Federal Loans

According to the U.S. Department of Education, the current interest rates are:

  • Undergraduate Loans: 3.73% (Unsubsidized and subsidized loans)
  • Graduate Direct Loans: 5.28% (Unsubsidized loans only)
  • Graduate and Parent PLUS Loans: 6.28%

It’s worth remembering that Federal Loan rates are fixed; therefore, they will remain the same throughout the entire duration of your study journey.

So, the calculation process to determine how much you’ll pay per year can be done in four simple steps:

  1. Get the Daily Interest: Divide your designated interest rate by 365
  2. Calculate the Interest Per Day: Multiply the Daily Interest by the amount of your student loan
  3. Determine the Interest Per Month: Multiply the Daily Interest by the number of days in a month (30)
  4. Get the Yearly Interest: Multiply the Interest Per Month by 12

If you still feel a little confused, don’t worry. Here you have an example so you can understand how Federal student loan interest works:

Let’s imagine you are a dependent undergraduate student who received a loan of $5,500. So, our interest rate would be 3.73%. 

First we get the Daily Interest: 3.73% (or 0.0373) ÷ 365 = 0.00010219

Then we calculate the Interest Per Day: 0.00010219 x 5,500 = 0.562

Next, we determine the Interest Per Month: 0.562 x 30 = 16.86

And finally, we have the Yearly Interest: 16.86 x 12 = 202.32

So, we would have to pay an annual interest of $202.32, which in a 10-year repayment term, the overall interest cost would be $2,032.

How to Choose a Student Loan for College

Private Loans

Now, private student loans are a whole different story.

As we already mentioned, private loans can lend you more money, but their interest rates are usually higher, and private lenders can offer you a fixed or variable interest rate.

While a private student loan interest rate will always depend on your circumstances and which entity you are asking, these are the fixed and variable rates from the best private lenders according to NerdWallet:

How to Choose a Student Loan for College

Source: NerdWallet

Generally, it’s safer to go for a fixed rate, but you should always check first. Maybe with a variable interest rate, you start with a lower percentage rate, which overall can end up being less than it would have been with a fixed rate.

The tricky aspect of private student loan lenders is that some require you to pay compound interest

How does this compound interest work? Well, instead of calculating the daily interest by multiplying the amount of your student loan, it’s calculated by this principal amount plus any accrued unpaid interest.

In other words, you pay interest on the interest that adds to your loan each day.

So, you determine the Daily Interest Rate and the Daily Interest by following the same steps as before:

  1. You divide your designated interest rate by 365
  2. And then multiply the Daily Interest by the amount of your student loan

But to get the Interest Per Month and Year, you need to sum the Daily Interest to your principal amount on a daily basis.

Still confused? Don’t worry again; we have a clear example for you to understand it better:

In this case, let’s imagine you have found a private lender that lends you $20,000 for a fixed interest rate of 7.5%.

So, you calculate the Daily Interest: 7.5% (or 0.075) ÷ 365 = 0.00020547

You continue with the Interest Per Day: 0.00020547 x 20,000 = 4.109

Now, for each day you need to add 4.109 to your loan balance.

Then, your interest rate would be as follows:

Day 1: $20,000 + $4.109 = $20,004.1

Day 2: $20,004.1 + $4.109 = $20,008.2

Day 3: $20,008.2 + $4.109 = $20,012.3

And so on. It may not look as much on a three-day scale, but imagine how much it would be in 5-years’ time (1,825 days).

How to Choose a Student Loan for College

Which One Should You Choose?

You are now ready to choose which loan type is for you by following all of these guidelines.

You should pick a federal student loan if you:

  • Want lower interest rates
  • Prefer fixed interest rates
  • Need a student loan that covers the basic cost of college
  • Prefer a repayment period that starts after you have finished school

You should pick a private student loan if you:

  • Need a student loan that covers most of the college costs
  • Don’t mind higher interest rates
  • Can start repaying monthly while studying
  • Can afford to pay compound interests

Either way, it’s important that you first know what your priorities are and how you’ll be able to repay the loan after you receive it.

Do extensive research and see which loan servicer suits you the best. Maybe you can apply for a subsidized loan that covers your attendance costs, or perhaps you can find a fixed-rate private student loan that lets you solve higher expenses.

Student loans are a world on their own, and it can be easy to get confused among so many options. And it’s even worse if you doubtfully receive one because you get mixed up on the interest rates and fall victim to the student loan crisis.

Luckily, we hope that you now understand how student loans work and how you can get them with this complete guide!

If you want more information on what you can do with student loans, check out our related articles: