This blog post was originally published in January 2018. It has since been updated to provide the most current and relevent information.
Last week, I thought financial aid was akin to black magic. All I knew for sure was it “helps students pay for college.” I wasn’t sure how or even who qualified for it, and I had a feeling I wasn’t the only one living in ignorance.
So, I called an expert.
Rebecca Decker is an admissions counselor for Pearson Accelerated Pathways and has been using her expertise to help hundreds of college students make good financial decisions for the past seven years (not to mention the four years she spent learning about and managing her own financial aid in college).
After an hour-and-a-half-long conversation with Rebecca, breaking down what financial aid is and how it works, I learned this government-sponsored financial program definitely isn’t black magic…but it isn’t exactly a fairy godmother either.
What is Financial Aid?
Most students don’t have the ability to pay for college out of pocket. Considering tuition, books, room and board, and other related fees, the cost can be substantial. Not surprisingly, most students need to research financial aid options.
Financial aid consists of a variety of components that help students pay for college, such as scholarships, grants, loans, and work-study programs. Although some types of aid do not need to be paid back, others do.
It wasn’t until I talked to Rebecca that I learned that financial aid does not always equate to “free money.”
“It’s absolutely possible to qualify for grants, which are essentially free money,” Rebecca said, “but most of the time, accepting financial aid means taking out federal loans.”
I suddenly felt ripped off. No one—NO ONE—ever told me that financial aid meant student loans. Having been raised to live debt free myself, the idea that student debt may be masquerading under a friendlier title didn’t sit well with me.
“If financial aid is just a loan,” I asked, “how is it any better than getting a private loan to pay for college?”
Turns out, there are a few differences between a federal student loan and a private loan:
Most federal loans don’t require a credit check.
Federal loans often have low, fixed interest rates, which vary based on the first disbursement date of the loan. The interest rate for Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans for undergraduate borrowers first disbursed on or after July 1, 2020, and before July 1, 2021, is 2.75% (A private loan could easily exceed 18%.)
Federal loans are tax-deductible.
Federal loans can also be deferred—most commonly, students will defer their loans for up to 6 months after they graduate (allowing time to get a job).
Lastly, federal loans are eligible for loan forgiveness in some special cases.
While this list may make federal student loans look nicer than what Mr. Local Banker Man would has to offer, it should be noted that student loans are still debt. Taking out a student loan means spending money you don’t have and that you will have to pay back... with interest.
Taking out a multi-thousand dollar loan at 18, with no career or even the guarantee of a good job once you graduate? That’s a financial gamble. For better or worse, it will impact your life long after college.
Given that, let’s talk about the different kinds of federal student loans you could apply for and the impact they can have on your financial future.
What is FAFSA?
The first step toward applying for financial aid involves filling out an application.
The Free Application for Federal Student Aid (or FAFSA) is exactly what it sounds like—your financial aid application. Completing this form is the only way to learn what kind of federal aid you qualify for. The purpose of the FAFSA is to allow states and colleges to determine which students are eligible to receive financial aid. It also helps them determine how much aid students will get. “The first thing students should know is that completing your FAFSA is not a commitment,” Rebecca said. Applying is not agreeing to accept aid. You’re just finding out how much you qualify for.
How Does FAFSA Work?
What kind of aid you qualify for is based almost solely on your tax information (for minors, that means your parents’ tax information). This is the broad measuring stick the government uses to determine your eligibility for various levels of financial aid. The more you make, the less aid you qualify for, essentially. While your state, school choice, and a few other elements (e.g., how many courses you’re planning to take) are factored in this decision, they’re all secondary to your yearly taxes.
It should also be noted that if you or your family’s financial situation has changed significantly from what’s reflected on your (or your parents’) most recent tax return, you may be eligible to have your financial aid package adjusted.
Types of Student Loans
Student loans fall into one of two categories: federal and private. There are two key differences between federal and private loans. The first is that federal loans have lower interest rates. The second is that federal loan repayment programs offer greater flexibility.
Direct Loans: Subsidized and Unsubsidized
Both subsidized and unsubsidized loans are granted at the beginning of a semester, and neither is required to be paid back until after you graduate (or otherwise disenroll from your school). No matter which year the loan covers, once you’re out of school, your payments begin.
The big difference between subsidized and unsubsidized loans is when you start paying interest.
An unsubsidized loan gains interest just like a private loan would: starting the day you take it out. The don’t-pay-until-you-graduate grace period only applies for your loan payments. Interest payments are still required throughout your time in school.
However, if you take out a subsidized loan, the government pays interest for you while you’re in school. Your personal interest payments will begin only after you graduate, along with the rest of your loan payments.
If you’re going to take out a federal student loan, Rebecca recommends pursuing a subsidized one.
“I remember the difference by saying ‘unsubsidized is uncool,’” Rebecca said. “Paying off the interest on an unsubsidized loan can be very stressful for students, especially if they aren’t earning much on the side while they’re in school.”
Plus, she mentioned, if you are earning an income while in school, you would be better served by putting that money toward paying for your next semester upfront and skipping the loans altogether rather than paying down a growing debt.
The fewer loans you take out, the less interest you pay. The less interest you pay, the cheaper college will be.
If you decide to walk the precarious loan path and don’t qualify for subsidized and unsubsidized loans, or if you have taken out as much as you can but still need extra money to cover your final college costs, there is a third type of federal loan to pursue. But in Rebecca’s opinion, it’s a very poor choice and should be avoided at all costs.
Direct PLUS Loans
Direct PLUS Loans work a little differently than both subsidized and unsubsidized loans:
First, PLUS loans require a credit check. So if you don’t have credit, your parents must act as co-signers. This means if you fail to pay it back, the loan burden will default to your parents.
Second, at 5.3%, the interest rate for PLUS loans is higher than that of a subsidized or unsubsidized loan.
Third, not only do PLUS loans gain interest from the day they’re borrowed, just like an unsubsidized loan, but you’re also required to pay an extra fee on top. Currently, the loan fee is equal to a little over 4% of the amount you borrow.
Bottom line: this loan is available, but it’s expensive—and possibly harmful to not just you but also your parents.
“When I was applying for school, my parents wouldn’t co-sign this loan for me simply on principle,” Rebecca said. Her family was one of the many who decided the potential dangers of applying for this type of loan outweighed the benefits of college. That’s serious.
Other Types of Financial Aid
Students should also know that they may qualify for a variety of “free” financial aid options, such as grants and scholarships.
While the loan portion of financial aid is what most students qualify for, there is a happier side to the process. By completing a FAFSA, you may also qualify for grants.
A grant is a free gift of money that the recipient is not required to pay back except under certain conditions (like if you disenroll early or make a similar change that alters your eligibility). These grants are what every student thinks of when they imagine financial aid, and it’s every bit as good as it sounds.
If you qualify for a grant, we recommend you take it before considering any of the student debt options we mentioned above.
The Federal Pell Grant
“Think of the Federal Pell Grant as a collective pool of money set aside by the government to help students pay for college. Each year, this money is distributed among applicants based on their need.”
For the 2020-21 school year, the maximum amount a student could receive from the Pell Grant was $6,345 per year. That’s a fair chunk, especially for students pursuing community college or another low-cost option. Of course, how much of this money you actually receive depends on your financial need, the cost of your school, whether you’re attending part or full time, and how many semesters you’re paying for.
Your “financial need” is the biggest consideration here. This is determined based on your most recent (or your parents’ most recent) tax return. And, unfortunately, there’s a large swath of individuals who fall into the camp of making too much to qualify for the Pell Grant while not actually making enough to actually pay for college. Curious if you’re eligible for Pell? The U.S. Department of Education provides a handy tool for estimating how much aid you’ll qualify for.
Rebecca wanted to go into detail about state grants as well—and what kind of money you may or may not qualify for according to your state. Unfortunately, state grants aren’t standardized, which means the information would be far too complicated and technical to relate in this post.
But it’s worth noting that if your state does have a grant to offer, you’ll find out by filling out a FAFSA. You can also contact your state grant agency to ask about possible grants.
School Grants and Scholarships
Like with state grants, this is another type of grant that isn’t standardized but is available by completing a FAFSA. However, you’ll need to apply to the school in question to gain access to the information.
If you’re accepted to the university in question, it’ll put together a financial aid award letter based on your FAFSA. You’ll receive this letter along with your notification of acceptance to the school. If you qualify for any of the school’s grants or scholarships, this letter will tell you.
Of course, you can also contact the school directly to ask about possible scholarships or grants you may qualify for. You might be able to find out about scholarships offered for specific majors.
Learn More About How to Pay for College
My conversation with Rebecca was more helpful than I could have hoped for, but it left me perturbed. When grant money is so difficult to come by and loans are so easy, it can be tempting to assume student loans are the best way to pay for college.
But that’s just not true.
At Accelerated Pathways, we believe college shouldn’t be a debt sentence. We help students avoid the need for student loans altogether by lowering their college costs through the use of affordable online courses. I’d encourage you to make a smart financial decision and avoid federal student loans. Learn more about how Accelerated Pathways can help you save money on your education and graduate debt free.
Special thanks to Rebecca Decker, one of our amazing admissions counselors, for taking the time to chat with me about this topic.