Loans 101: A Graduate’s Guide to Taking Out and Paying Off Loans
Most of us understand the basics of loans already. You need a certain amount of money, so someone lends it to you, and you eventually pay them back with interest attached. However, the process of taking out, consolidating, and repaying loans is much more complicated.
In this article, we’ll review some of the essential information you should have as a young adult considering taking out a loan. We’ll focus on a type of loan you may have already taken out – a student loan – and loans you may need to take out in the future, like a home loan.
Key Takeaways
- Student loans can be subsidized or unsubsidized. The former means students don’t accrue interest on their loans while they’re in school and during a six-month grace period. The latter accrues interest throughout the entire life of the debt.
- The payment pause will come to an end this fall. At that point, students will have to resume making loan payments, unless they see their debt wiped out by Biden’s forgiveness policy before then.
- A secured loan – like a mortgage – carries collateral your lender can seize in the event you don’t make your monthly payments
Student Loan Basics
College tuition has become increasingly expensive over the years. Recent data has shown average tuition costs for four-year public universities climbing above $ 25,000 for out-of-state students. Because of this, taking out a student loan may be essential to your attending college.
Public Loans
There are two types of student loans you can take out: public or private. A public loan, also referred to as a federal student loan, is taken from the U.S. government, with interest rates set by Congress. Within this category are two additional categories of loans: subsidized and unsubsidized.
A subsidized loan allows you to take out money without owning interest while you’re in school and during a six-month grace period after graduating. An unsubsidized loan accrues interest throughout the borrower’s time in school. Though they can decide whether to pay it off during or after school, the borrower is fully responsible for the interest payments.
Note that only undergraduates qualify for subsidized student loans. If you’re a graduate student applying for a federal student loan, it will be unsubsidized. To apply for a federal student loan, you must complete a Free Application for Federal Student Aid (FAFSA).
When paying off your public student loan, there are a few things you can do to save money. You can pay off your debt immediately, pay more than the minimum monthly balance, and set up an automatic debit feature, which may marginally lower your interest rate.
Remember that the cost of your debt will continue to increase as long as interest is applying, so paying off your student loans faster translates to spending less money overall.
Private Loans
Private loans can be taken out in a similar way, but you’ll go through a private lender rather than the federal government. The private lender will consult your credit report when gauging how much they want to lend you. If you’re young and don’t have a robust credit report, the private lender may request a co-signer for your loan.
Taking out a public loan before a private one is generally advisable since interest rates tend to be lower than the former. However, every person’s situation is different, which may not be the case for you. Generally, people take out private loans when the amount of their public loan is insufficient to cover tuition costs.
Another benefit of public loans is extra flexibility in the repayment period. If you take out a public loan, there are often options for a graduated repayment plan, meaning the minimum monthly balance starts small and grows over time. Extended repayment is also an option, allowing you more time than the typical 10-year repayment period.
Public loans also have the potential for forgiveness, especially if you take a public-service job. Private loans may offer some of these features for repayment, though it’s less common. So if you’re considering refinancing your public loan (selling it to a private lender), consider that you’ll likely lose this flexibility.
Current Events Affecting Your Student Loan Repayment
Recently, many students and graduates have enjoyed not making student loan payments because of “forbearance,” the payment pause put into place during the pandemic. That interest-free period, though, will come to an end this fall.
Per the latest federal debt ceiling bill guidance, the payment pause will end 60 days after June 30, 2023. That means interest will resume on your accounts starting September 1, so payments will be due again in October of this year.
At the same time, President Biden’s federal student debt cancelation policy is being debated in the Supreme Court, with a verdict to be announced later in June or July of 2023. It’s possible your student loan debt will be canceled entirely because of this policy, but we’ll have to wait and see what the Supreme Court decides.
Personal Loan Basics
A type of loan you likely haven’t encountered yet but may sometime soon is a personal loan. This kind of loan can help you pay for a one-time, large purchase. Some people take out personal loans to pay for home repairs, a useful purchase since it will hopefully raise the value of your home.
Most personal loans are unsecured, meaning any collateral doesn’t guarantee them. A secured loan, like an auto loan or mortgage, includes collateral (your car title or house) that allows the lender to have more confidence you’ll pay them back. Unsecured loans are riskier for lenders and often carry higher APR rates as a result.
Repayment periods for unsecured loans can range from two to seven years – though some people may be offered a repayment plan of up to ten years.
Another type of personal loan you can take out is a debt consolidation loan. This type of loan allows you to bundle multiple unsecured debts into one and is useful if the new loan will give you a lower interest rate than those attached to your existing debts.
It’s generally not advisable to take out a personal loan to pay for a large, discretionary purchase like a vacation, or for emergency expenses. It’s often better to build an emergency fund that could cover up to six months’ worth of living expenses.
Home Loan Basics
When applying for a mortgage as a first-time homebuyer, you’ll need certain things ahead of time to be approved. First, you’ll need proof of income for a minimum of two years. Lenders will want to see if you can pay the mortgage amount. You’ll want to be able to make a down payment of at least 3.5% and have a credit score of 620 or higher.
As a first-time homebuyer, getting around one or more of these requirements is possible, though it’s generally better if you meet all three.
If you can qualify for a conventional home loan, that’s ideal. Conventional loans usually carry lower interest rates than loans backed by the government. However, you’ll need a higher credit score, lower debt-to-income ratio, and a more significant down payment to qualify.
Conventional loans can be divided into two categories: conforming and nonconforming. Conforming loans can be sold on the secondary market and meet specific requirements set by government-sponsored enterprises like Freddie Mac. Nonconforming loans have their guidelines set by the person underwriting the loan, and, therefore, can’t be sold on the secondary market.
The more common loan option for first-time homebuyers is a Federal Housing Administration (FHA) loan. An FHA loan allows for a lower down payment and also requires borrowers to pay a mortgage insurance premium.
Fixed- and Floating-Rate Mortgages
Another consideration you’ll have to make when getting a home loan is whether you want a fixed- or floating-rate mortgage. The former is a more safe option, as you’ll know how much you’ll pay toward the loan for the entirety of its existence. If you secure a fixed-rate home loan when rates are low, it will be locked in for the entirety of the loan’s lifetime.
A floating-rate mortgage is helpful to first-time homebuyers because they usually come with a lower introductory rate that slowly increases over time. If you expect your income to increase over time, this kind of mortgage may be right for you. However, they carry additional risk, since your loan’s interest rate may jump higher than a fixed-rate mortgage, depending on the market.
There are many considerations to consider when applying for a home loan. The critical thing to remember is that the more you’re ready to put into a down payment, and the higher your income, the greater your negotiating power with lenders.
Tackling Debt: Snowball vs. Avalanche Method
There are many ways you can approach repaying debt. Two popular methods are the snowball and avalanche methods. The snowball method involves paying extra toward your smallest debt first, then redirecting the money you put into that debt toward the next smallest debt. The avalanche method involves paying off debts with the highest interest rate first, then moving on to the debt with the next highest interest rate.
The method you choose will depend on the kind of debt you have. Consulting with a financial expert may be a good idea as your finances become more complicated.
The Bottom Line
Most of us will take out a loan at some point in our lives. Student loans can help you attend college, and may not carry interest for a time if you can secure subsidized loans. Personal loans are a good option for large, one-time purchases, allowing you to consolidate debt. There are many different types of home loans, and you’ll want to conduct extensive research before applying for one as a first-time homebuyer.
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