Student Loan Definitions: What You Need to Know Before Borrowing
A student loan is borrowed money from a lender to pay for tuition, fees, living expenses and other costs associated with seeking higher education. Because it’s a loan, you or your parent must repay the borrowed amount plus interest, although repayment is typically deferred until the student has left school and for six months afterward.
Student loans are most commonly borrowed from the federal government because it’s historically awarded lower interest rates and greater repayment protections — without requiring borrowers to have strong consumer credit. Debt could also be lent by state government authorities, banks, credit unions and online companies, which do take credit history into account when quoting rates and terms.
Defining a student loan, it turns out, is pretty simple. Unfortunately, other student loan definitions are far more complex.
Student loan definitions you need to know
Only 12% of college students with education debt reported being “very confident” in their knowledge of loans and how they work, according to our 2019 survey on student loan misconceptions.
Knowing the basic student loan definition is just the first piece of the puzzle. Here are 21 more:
1. Capitalization 2. Consolidation 3. Cosigner 4. Debt-to-income ratio 5. Default 6. Deferment 7. Delinquency 8. Expected Family Contribution (EFC) 9. Forbearance 10. Grace period 11. Interest rate 12. Lender 13. LIBOR 14. Loan forgiveness 15. Loan servicer 16. Master Promissory Note (MPN) 17. Principal loan 18. Refinance 19. Repayment term 20. Subsidized loans 21. Unsubsidized loans Plus: Knowledge is power when it comes to student loan definitions
Capitalization
Loan amounts grow because of capitalization — that’s how student loan interest works.
Capitalization of interest is when the interest that accumulates on your student loans is added to the principal balance. Interest can add up quickly and can add to the sum of your principal, making it tough to pay back student loans.
Consolidation
To consolidate is to group. In the case of federal student loans, a borrower might consider grouping numerous loans with numerous servicers into a direct consolidation loan. Consolidating would simplify your repayment, giving you one new, larger loan with one servicer.
Consolidating won’t save you money the way that refinancing would. The interest rate of your direct consolidation loan would be a weighted average of your previous loans’ rates, plus a small percentage on top.
There are more factors to weigh when deciding whether direct loan consolidation is right for you.
Cosigner
Many private student loans require a cosigner. A cosigner is typically a parent or relative with good credit that signs the promissory note and is responsible for the student loan if the primary borrower is unable to make payments.
You might need a cosigner if you have a limited (or poor) credit history and are applying for a private student loan. But consider the pros and cons of student loans without a cosigner before making a final decision.
Most federal loans don’t require a cosigner, but you might need a creditworthy endorser for a direct PLUS loan.
Debt-to-income ratio
Private lenders look at the ratio between your outstanding debt and your annual income when evaluating you as a loan applicant and deciding what rates to offer you. It’s important to know your debt-to-income ratio (DTI) when shopping for a loan.
You’re better off with a lower DTI, which would put you in a better position to pay off your loans.
Default
If you fail to make a monthly payment for 270 consecutive days (or nine straight months), your federal student loan will enter default. Your lender, the Department of Education in this case, will report the default, causing harm to your credit report.
That’s just scratching the surface of everything you need to know about student loan default.
There’s even less room for error on many private student loans, for example. Your lenders could skip past delinquency and push you into default after missing a single monthly payment.
Deferment
Per the student loan definition on the federal front, you can pause repayment for as long as three years by applying for one of numerous forms of deferment. You might be able to secure deferment if you become unemployed, for example, but take time before deciding whether loan deferment is right for you.
Deferment is doubly helpful for direct subsidized loans, as it stops interest from accruing. The same isn’t true for direct unsubsidized loans.
Private lenders might or might not offer some relief. You should compare the economic hardship protections offered by private lenders before taking out a loan in the first place.
Delinquency
Although delinquency can lead to default, a more serious predicament, you are delinquent on your student loan as soon as you miss a single payment.
Delinquencies are reported to credit agencies. They don’t cause as much damage to your credit report as a default as long as you get back on track with repayment.
Expected Family Contribution (EFC)
The student aid report you receive from schools will estimate how much you and your family can reasonably contribute to the cost of your education. This estimation is computed based on the family income information you entered on your FAFSA.
A low Expected Family Contribution means you might be eligible for more financial aid, such as grants, a work-study program or subsidized loans. A higher EFC, on the other hand, means you might be on the hook for a larger percentage of your cost of attendance.
Forbearance
If you don’t qualify for a deferment, forbearance also allows you to pause your student loan payments for as much as 12 months at a time. It might be offered at the discretion of your federal loan servicer. It also won’t stop interest from accruing on your loans, even subsidized loans.
Private lenders might offer forbearance in some form or fashion.
It’s important to ask your lender or servicer about the protections it offers before deciding on the best way to pause your student loan payments.
Grace period
A grace period is a set amount of time, typically six months, before your repayment begins. You enter your grace period upon graduation, after leaving school or dropping below half-time enrollment.
The student loan definition isn’t black and white: Not all loans have a grace period, and interest might still accrue on your loans.
But you’ll want to make the most of a grace period if you have one. It may be wise to make loan payments during this period because interest accrues on your loan while you wait to repay it.
Interest rate
When you borrow money from the federal government or a private lender, they want to make sure they are receiving a return on their investment. As part of the lending process, they will add interest to your loans.
If you are taking out federal student loans, the interest rate is set by Congress. Current interest rates for federal loans are fixed, meaning they will remain the same throughout the life of your loan. Private lenders might offer fixed or variable interest rates.
A variety of factors determines student loan interest rates.
Lender
If you borrow money, you have a lender that gave you the money. For student loans, the lender could be the Department of Education, as is the case for many federal student loans. It can also be a bank, a credit union or another private company. It’s also worth noting that your private student loan could be sold to another lender.
You might take out a $5,000 loan with CommonBond as your lender, for example. Similarly, SoFi could be your lender on a separate private loan.
No matter your lender, it’s wise to ask if a different company will act as the servicer of your loan. The servicer, which might not be your lender, is your go-to source for troubleshooting your loan.
LIBOR
Although Congress sets the interest rates for federal loans, private lenders take their cue from the Federal Reserve and the London Interbank Offered Rate (LIBOR).
LIBOR is an average interest rate itself. Its fluctuations are particularly impactful if you’re shopping around for a private loan or selected a variable interest rate loan and are now at the mercy of the market.
Loan forgiveness
Your federal student loan could be partially or fully forgiven if you qualify for one of the education department’s loan forgiveness programs. Typically, you can receive this form of relief if you make consistent payments over a specific period, work in a public-service field and submit supporting documentation with your application.
Some loan forgiveness programs could delete your student loan debt immediately. Others, like the Federal Perkins Loan cancellation program, might offer you complete forgiveness 15%, 20% or 30% of your loan balance at a time, over a five-year period.
Loan servicer
When it’s time to make payments, you send your money to your loan servicer. They handle all the payments for your student loans. If you have any questions about your repayment plan or are struggling to make payments, you want to talk to your loan servicer.
If you have a federal loan, for example, the Department of Education acts as your lender, but your servicer might be Navient (or one of the other federal loan servicers). Because loans can be transferred, it’s important to know how to track down your loan servicer in a pinch.
Master Promissory Note (MPN)
If you take out federal student loans, you must sign a Master Promissory Note (MPN). This is a legal document that holds you accountable for paying back loans, fees and interest owed to the Department of Education.
An MPN lets borrowers take out multiple student loans for a period of up to 10 years, so long as your school allows it. Your MPN will outline all the terms and conditions of your student loans, so be sure to read carefully before signing.
Principal loan
The principal is the amount you originally borrowed when taking out student loans — before any interest or fees were added on. It’s important to know this student loan definition because your payments must first go toward any outstanding fees and interest before going toward principal. This is one of the reasons to make extra payments on your student loans.
When interest capitalizes, it’s added to your principal. Depending upon your loan type, you might graduate with a larger loan principal than the one you started with as a freshman.
Refinance
Refinancing your student loans allows you to take multiple loans (and their various servicers) to the private lender of your choice and potentially score a better interest rate or monthly payment.
As you consider refinancing your student loans, be aware that working with a private lender isn’t a wise move if you want to keep your federal loan protections or are working toward loan forgiveness.
Repayment term
Your repayment term, also known as your repayment period, is how long you have to pay back your student loans.
Federal student loan borrowers are enrolled in the Standard Repayment Plan, which has a repayment term of 10 years. You might be able to extend your repayment term through a different repayment plan, though you’ll end up paying more in interest over time.
Subsidized loans
Direct subsidized loans are offered to students who demonstrate financial need. They’re great because the education department pays your interest while you are in school and during your grace period or deferment.
Unsubsidized loans
Direct unsubsidized loans are available to anyone regardless of financial need. The bad news is you are responsible for every cent of interest that accrues, even while in school or during deferment. You could lessen or erase the toll, however, by making in-school loan payments.
There are also other differences between unsubsidized and subsidized loans.
Knowledge is power when it comes to student loan definitions
As a young adult, it can be overwhelming to read a legally-binding contract full of unfamiliar terms. And when you sign up for something you aren’t 100% clear on, that’s when you run into trouble.
It’s no different when you’re learning to speak the language of stocks or mastering common mortgage terms before buying a house.
So before financing your education, consider these 21 important student loan definitions. Understanding student loans now can help you avoid lots of confusion or stress when it’s time to pay up.
Melanie Lockert contributed to this report.
The post Student Loan Definitions: What You Need to Know Before Borrowing appeared first on Student Loan Hero.
