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Following up on our previous discussion with college admissions counselor Lindsay Phillips, Booth leads you through the different types of student loans, including subsidized and unsubsidized loans, their interest rates, and how interest accrues. If you're navigating loans for higher education and want to be equipped in your decision making, this episode is for you!
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This podcast is produced by Rooster High Productions.
Creators & Guests
What is MOM-enomics with Booth Parker, CPA?
Real moms. Real mom financial issues. Real moms in business. Real stories. I am Booth Parker. A CPA, wife, and mom that loves all things home and family. In this podcast, I talk all things money for moms, families, and small business. From tips to ideas to info you just need to know, I break it down so moms can apply it to their own families and businesses!
MOM-enomics S3E2
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Introduction
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[00:00:00]
Booth: Today on MOM-enomics, we are going to be talking about student loans. So if you missed the last episode where I sat down with Lindsay Phillips, a professional college counselor, and I asked her all the questions about the college application process, you definitely want to go back and watch that episode It is fantastic and it's filled with a ton of great information, but during that episode, we very briefly touched on student loans.
So I'm going to give you a little more detail on the different ones that are available and how the interest on them works.
Recap of FAFSA and Financial Aid
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Booth: So just to give a little recap from the prior episode, the FAFSA, which is a form you'll have to fill out that [00:01:00] opens on October 1st of each year, The FAFSA gives you what's called your SAI, your Student Aid Index. Used to be called the EFC, it's a little different now. Uh, and this will tell you the financial aid you are eligible for.
And the sticker price, as you might find when you're googling the cost of a college or something like that, that schools post on their website, that is rarely the amount the student is actually going to pay. So don't let some of those sticker prices shock you. And then you have what's called the cost of attendance, the COA.
And this is a college's total estimated cost for one year. Everything from tuition, room and board, books, supplies, some transportations in there. All of that, all in one. And it's important that you apply for each year. every grant and scholarship that you can be eligible for. These monies do not need to [00:02:00] be repaid and they can greatly, greatly lower the amount that you end up paying for college.
And remember, most schools allow you to stack your scholarships. So that's definitely something to check on with the school you're applying to. If you have multiple scholarships available to you. And then student loans should be a last option. Unfortunately, a lot of people still have to take student loans out, and it is important if you have to take a student loan out to understand the way they work.
Understanding Federal Student Loans
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Booth: So federal student loans. So these are going to be preferred over private student loans, and they are based on your financial need. So the best one you would want to qualify for is a subsidized federal student loan. Not everyone's gonna qualify for this, but this is the best [00:03:00] case scenario for a student loan.
So in this federal student loan, the government is paying the interest while you are in school and during any grace periods. So the interest that is your responsibility, it doesn't begin accruing until the actual repayment plan starts. So you're saving a good bit in interest right there. Then you have the federal Unsubsidized.
So these, they do not pay the interest for you, and that interest begins accruing as soon as you receive the funds. It doesn't wait until the repayment plan starts, so it begins accruing as soon as the funds are received, and it's your responsibility to pay that interest.
Interest Rates and Accrual
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Booth: So what are the interest rates? So if you're listening to this podcast, um, just audio, you may want to go check out the YouTube version. I've got some [00:04:00] slides showing all this information and it could be, um, Just make the dialogue a little easier to follow and just be great references for you down the road.
So here, what are the interest rates? So these are the published rates. It's a screenshot directly from their website. So you can see that the direct subsidized and unsubsidized loans currently have a fixed interest rate of 6.53 percent. That fixed interest rate means it will not change for the life of the loan.
So that will always be your interest rate. Also here on this chart are rates for graduate school, professional type loans, but right now we're just focusing on this undergraduate one. You can see the rates are higher for graduate students and professional students. And the interest on these loans accrues daily.
So you would basically take your, your amount of [00:05:00] your loan times your interest rate, and that would give you your. Annual interest due, and then you would divide that by 365. So that would give you your daily interest rate that is accruing.
So let's just kind of look at a simple example. So if you take out a $20,000 loan at that current fixed rate of 6.53%, your daily interest that's going to accrue is 6.53. So if you have the direct subsidized loan, that daily interest is paid for you while you're in school and during your grace period and any deferment periods.
With the direct unsubsidized, that daily interest is your responsibility to pay during all periods. So the interest adds up, even though you aren't required necessarily to be making payments during all the periods on that unsubsidized loan, [00:06:00] the interest still is accruing, it's adding up, and depending on your repayment plan, it may even be capitalized onto your loan balance, the principal amount of your loan.
So with direct subsidized, that interest doesn't begin accruing until the repayment plan starts. So it's not accruing that whole time just when the funds were received. With the direct unsubsidized, that interest, prior example of 6.53 a day, it is accruing from day one when the funds are received. So if the repayment plan starts one year after receiving the funds and you haven't paid interest along the way.
That one year interest accrual is going to be $1,307 that you're responsible for paying. Generally, you've got multiple years in there because you're most likely going to be in school for four years. So just think about all of that interest that's accruing [00:07:00] along the way. So if your repayment plan capitalizes interest, then that $1,307 that had accrued would be added to your principal balance.
And in this example, it was a $20,000 loan. And so that new principal balance would be $21,307 and interest would now be calculated on that higher balance. So it's very, very important to know if your interest will be capitalized because it can obviously increase the amount of total interest you'll end up paying.
So here's a capitalized example, and we're just going to assume that no payments are made during four years of school, and that $10,000 is what was received at the beginning of year one. At the 6.53 percent fixed rate, it accrues $653 in interest in that first year. The principal balance is now $10,653. So [00:08:00] the next year, that interest is calculated on 10,653 dollars. So the second year, your interest is 695 versus the 653 the first year. And you can see in this example, it goes down through year four, where at the end your principal balance is now $12,878. Where the interest accrued each year was added to the principal balance. So very, very important to know if your interest will be capitalized, especially if your loan is over a long term, as far as until your repayment plan starts, because all of that's adding up.
Private Student Loans Explained
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Booth: And then the kind of last resort would be a private student loan. So if you don't qualify for either of the federal student loans, you may have to take out a private student loan. And these are offered through various lender sources. There's [00:09:00] online sources, there's banks, the whole nine yards. There's a whole lot of options for private student loans, and it's very, very important to know the terms of your loan because they can be vastly different and can greatly change the amount of interest that you're going to end up paying.
The rate that you get in these loans is credit dependent. It's kind of like a normal loan you would get at the bank. So if you do not have You have bad credit and most young people don't have credit yet, so at least you don't have bad credit yet, but you're going to need a cosigner. So you're bringing a whole nother party to the table.
But if you are bringing a cosigner to the table, the stronger their credit is, the better your rate is going to be. So when considering a cosigner, consider someone with good credit. good credit that is willing to go sign your loan for you. And in the [00:10:00] private student loans, they could have fixed rates or they could have variable rates.
Very important to know if yours is a fixed rate like the federal ones just were, where the interest rate is going to stay fixed that same amount the whole life of the loan. Whereas variable rate, the interest rate can change throughout the life of the loan and it can greatly change the amount of interest paid. Now with the private student loans, almost always the interest begins accruing when the funds are received. And then that interest that is accrued and unpaid is almost always capitalized as well. So it's very important to know the terms of your loan, what the rate is, fixed or variable, What's, uh, when the interest is accruing, if the interest is capitalized, and how your payments will be applied towards your principal [00:11:00] balance when your repayment plan starts.
So it's kind of hard to give very specifics for private student loans because they can be so different. It's very important to just know the terms of your loan and how it's going to work and how much you're going to be paying for it.
So with the variable rate thing, a lot of times a variable rate loan comes into play when interest rates are low. And so it's very enticing to do the variable rate loan because that starting rate is most likely going to be lower than what a fixed rate loan would be. So you might get the option of. 4. 5%.
If you've got a $10,000 loan, that interest for one year is $450. But if it's a variable rate and that interest rate goes up to, say, 7. 5%, now you're owing $750. So that's a really big difference [00:12:00] in the total amount of interest. So, variable rates are generally not a good option because there is so much volatility, so to speak, in how much interest you will end up paying.
Summary and Final Tips
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Booth: So, in summary, just kind of remember that student loans, are a last resort. You want to maximize grants and scholarships, and you do want to keep up with the interest payments as they accrue as best you can. I know that these loans are used because you don't have any money, but keeping up with those interest payments if you can is definitely crucial, um, and especially if your repayment plan is going to capitalize that interest that's accruing. And then for the private loans, know the terms of your loan. The problem that so many people have with student loans is they don't [00:13:00] know the terms or understand them going into the loan.
They don't know if their interest is going to be capitalized. They don't know if their rate is going to change all of these things because there are a lot of repayment plans where you can end up where your monthly payment isn't even covering the interest that is due And so when that happens that interest that hasn't been paid keeps getting added on to the loan And so it's This never ending cycle because the principal balance is going up because the interest isn't getting paid in full.
So it is very, very important if you take out a student loan, whether it's federal, subsidized, unsubsidized, or last resort private, it is essential to know the terms of the loan and what that repayment schedule is going to look like and what the total interest is going to be [00:14:00] on it based on the way it's structured and how the interest will accrue.
So I hope this information has been helpful for you to kind of get a little better understanding of how a student loan may work and what the interest is going to look like over the course of the loan while you're in school and then afterwards when the repayment starts to kick in.
Booth: So stay tuned for next time. Thanks for watching.
[00:15:00]