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How Student Loans Work

More on Federal Student Loans

student loan application
Even if you're able to get federal loans, the amount you qualify for may not cover the entire cost of your education when you factor in room and board, activity fees, technology fees, books and supplies, and other costs Jupiterimages/Getty Images

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While federal student loans are some of the best available, there are some downsides.

For instance, there are also usually limits to the amount you can borrow from the U.S. government. In 2020, the limits for the direct subsidized and unsubsidized loans for undergraduate students range from $5,500 to $12,500 per year as determined by the student's dependency status, according to Federal Student Aid, an office of the department of education. The total aggregate borrowing limit for a dependent undergrad is $31,000 or for an independent undergrad is $57,500.

Setting borrowing limits might be helpful in keeping young students from incurring too much debt while in school, but with the average private school tuition ringing in at $36,801 per year in 2019-2020, many parents have to take out extra loans to cover costs.

Keep in mind that in addition to tuition, families are responsible for room and board, activity fees, technology fees, transportation, books and supplies and other costs. For some people, federal student loans won't cover all of college, and so financial aid advisers tend to suggest using federal loans as ways to close the gap between tuition and fees and scholarship and grant money.

"The best guideline is to tell students that they should borrow only as a last resort and, if they must, to borrow as little as possible," says Andrew Pentis, personal finance expert and certified student loan counselor with Student Loan Hero. "From that point, they can work out the math to see if they can actually afford what they're planning to borrow. They can do this by estimating their monthly payments down the road and projecting their future post-tax salary. They can even create a mock postgraduate budget to ensure the monthly payment is a feasible amount." A variety of calculation tools are available on the Student Loan Hero website.

In 1998-1999, 60 percent of direct loans were subsidized, but by 2018-2019, only 29 percent were, according to CollegeBoard's "Trends in Student Aid 2019" report.

Whichever type of loans you are awarded, and it will likely be a combination of the subsidized and unsubsidized, disbursement of the funds will go to your school, not to you. The school will tally the total amount of your tuition, fees and any other charges the school levies, and then subtract any scholarship, grant money or any other financial assistance you may have. Any remaining balance will be deducted from your student loan, and if there is money left over, you can opt to receive it in the form of cash, a check or a direct deposit into your bank account. Know that you will also have to pay loan fees, which will also be deducted before you receive any surplus.

You can also have the school hold the surplus from your student loans for the next academic year, which is the wise choice. After a year in school, you will have a better idea of the amount you'll need to borrow for your second year. You may need to borrow less than you think.

If you've exhausted your limit for federal student loans and still find yourself short on money for tuition, it's time to look to the private sector for help.

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