The Great Student Loan Debate: Part 1

That student loan you’re about to take out for the fall could end up costing you hundreds, and in some cases, thousands of dollars more in future interest than it did last year. That’s because the fixed interest rate set on federally subsidized loans is scheduled to double on July 1st, from 3.4% to 6.8%. In addition, changes to how interest is accrued during your six-month grace period following college could also whack you with hundreds more in interest, as well.

This is not welcome news to students and their families struggling to keep education costs in check.

So, should you be worried? That depends on your situation and what loans you want to take out to fund your education. In general, the impact will probably be minimal on students that are taking out a lot of loans from different sources (as most are doing these days). On the other hand, for students that are counting solely on federal loans, the changes are going to sting a bit.

This article is broken up into two parts. In part one, we will look at the potential changes in student loans and examine how those changes could impact your repayment schedule. In Part 2, we will examine options available to you if you run into trouble paying down your debt after graduation, including a federal program that could help reduce your payments significantly.

Know Your Loan

The rate hike only affects one type of loan: federally SUBSIDIZED Stafford loans. Chances are, you have a mix of several different federally-backed loans (unsubsidized Stafford, Perkins, PLUS etc) and even some private student loans (Sallie Mae, Discover, etc.) under your belt, so take note that this only impacts your federally subsidized Stafford loans. The interest rates on all the other loans you take out, except private loans with variable interest rates, will stay the same.

Going Forward

The interest rate hike only impacts NEW loans scheduled for disbursement in the fall of 2012. That means all federally subsidized Stafford loans issued before then will keep their same interest rate, which range from 6.8% to 8.5%. Since all federal student loans are fixed rate loans, you can be assured that the interest rate you have now will follow you for the life of the loan.

Young Bucks

The hike will only impact UNDERGRADUATE students. Graduate students will actually become INELIGIBLE for subsidized Stafford loans all together starting on July 1st. This is a shift that most grad students probably aren’t prepared for. Private loans and other federally-backed loans will carry a minimum interest rate of 6.8% for the vast majority of grad students, so that could be something to think about before applying for masters programs going forward.

The Limit

The maximum a student can borrow from the federal government to fund his or her entire undergraduate education currently stands at $31,000. But only $23,000 of that amount is allowed to be subsidized Stafford loans. That means that a student attending a four-year college can only take out around $5,750 a year in federally subsidized Stafford loans per school year.

The Damage

If a freshman this fall ends up taking out the maximum amount of subsidized Stafford loans over the next four years, the higher interest rate will cost the student an extra $4,600 over a 10-year repayment period. That amounts to around $38 a month.

Fall From Grace

It should be noted that July 1st will also bring changes to the standard six-month grace period new graduates receive in paying back their loans. Currently, the grace period, which starts the day after graduation, exempts a student from making any payments on the loan. That’s going to stay the same. What changes, is that interest will now start accruing the day after graduation, not at the end of the grace period, which had been the case for years. That interest will be capitalized (added to your loan), raising your total balance.

Reality Check

With the all-in cost for in-state public college averaging around $21,500 per year and the cost for a private college sitting at $42,224 a year, it’s important to note that for many students and families, this change in interest rates will probably be a drop in the bucket if the majority of the student’s college funding derives from loans.

Cyrus Sanati is a frelance financial journalist whose work has appeared in dozens of leading publications, including The New York Times, BreakingViews.com, and WSJ.com. Follow Cyrus on Twitter @csanati.