Student loan terms to know before applying for a loan

Graduating with student loan debt isn’t ideal, but it’s a necessity for many college students. Understanding the definitions of various student loan terms can help you make more informed decisions and potentially reduce the long-term costs associated with college debt.

Whether you’re an incoming freshman or an outgoing senior, here are some of the more common terms and what you need to know about them.

Accreditation

Any postsecondary education you receive must be from an accredited institution if you plan on using federal student aid. Private lenders will also require that you attend an accredited program — whether that be a university or vocational program — in order to receive funding. The accreditation must be under a nationally recognized accrediting agency. If not, it may be a case of a fraudulent university.

Autopay

Almost every student loan will give you the option of signing up for automatic payments, or autopay. Rather than manually paying your loan each month, the funds will be deducted directly from your bank account. It is a convenient process, but you should still ensure that your payment is successful to avoid late or missed payments.

In addition to the convenience, many lenders — including most federal student loans — offer an autopay discount. This reduces your annual percentage rate (APR), often by 0.25 percent. Over the course of your loan, an autopay discount can reduce the amount you pay back by hundreds of dollars.

Borrower defense to repayment

The borrower defense to repayment program was designed for students who received federal aid. If you attended a school that misled you, engaged in misconduct or violated state law, you may be eligible to apply.

In order to have your loans forgiven, you must be able to prove misconduct. It can be a lengthy process, and it only applies to federal loan programs. Your private loans will likely not be affected by the borrower defense to repayment program.

Capitalization

College students and their parents typically don’t have to make payments on their student loans while the student is in school, deferment or forbearance. But if you have private student loans or unsubsidized federal student loans, interest still accrues during those periods. Interest also accrues on subsidized loans during forbearance.

Once the grace period ends, the student loan servicer or lender capitalizes that interest, adding it to your principal balance and increasing how much you owe. This essentially means you’ll be paying interest on top of interest. Fortunately, many servicers and lenders allow borrowers to make interest-only payments to avoid capitalization.

Co-signer

If you can’t get approved for a private student loan or for student loan refinancing on your own, you may be able to improve your odds with a co-signer. A co-signer is someone who adds their name to your loan application and effectively takes responsibility for making payments if you can’t.

If someone co-signs a student loan with you, the account will show up on both of your credit reports. Missing a payment or defaulting can hurt both of your credit scores. Some private lenders offer a co-signer release program, which allows you to remove a co-signer from your loan if you meet certain payment and credit criteria after you graduate.

Debt-to-income ratio

Your debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward debt payments. For example, if your monthly salary is $5,000 and you have $1,200 in debt payments, your DTI is 24 percent. You will likely need to have a debt-to-income ratio below 50 percent in order to qualify for student loan refinancing.

If you’re applying for a mortgage, your student loan payments will be included in your back-end DTI, which includes all your debts. However, mortgage lenders will also calculate your front-end DTI, which includes only housing-related costs.

Delinquency and default

If you have private student loans, what constitutes delinquency and default varies by lender. With federal loans, delinquency begins as soon as you miss a payment, and it’ll be reported to the national credit bureaus once you’ve been delinquent for 90 days or more.

Federal loan default typically occurs if you haven’t made your scheduled payments for 270 days. Once your loans are in default, the entire balance is due immediately, and you may face other consequences. Fortunately, it’s possible to bring your loans out of default and get back on a regular schedule.

Expected family contribution

Your expected family contribution (EFC) is the amount your family is expected to pay for postsecondary education. EFC takes into account income, family size, financial assets and other factors. It is an important component when considering need-based financial aid like grants and Direct Subsidized Loans.

Every student’s EFC will be determined by information submitted through the FAFSA. However, you can use the Federal Student Aid Estimator to get an idea of what you might have to pay.

Income-driven repayment

The federal government offers several income-driven repayment plans, which can reduce your monthly payment to a percentage of your discretionary income. These plans also extend your repayment term by up to 25 years. If you have a balance at the end of that term, it will be forgiven.

Income-driven repayment plans can be a lifesaver for borrowers who are struggling to make payments. That said, private student lenders typically don’t offer them.

Interest rate and APR

The interest rate on a student loan is the percentage that student loan servicers and lenders use to calculate how much you owe on top of your outstanding student loan balance every month. The annual percentage rate (APR) is the full cost of borrowing, which includes interest, fees and other charges.

If there are no fees or other charges associated with your loan, the interest rate and APR are generally the same. If there are, the APR will be higher than the interest rate. In most cases, the rate that companies advertise is the APR. With federal loans, the interest rate and fees are listed separately on the Education Department’s website.

Loan term

The total amount you pay back — the principal and interest — on a loan is spread out over years. This is the loan term, the amount of time you have to repay your loan. For federal student loans, the standard repayment plan is 10 years. Private lenders allow you to choose your loan term, though in most cases, it will be between 10 to 20 years.

For federal loans, the repayment period doesn’t start until six months after you graduate. This means your loan term will be ten years after you begin making repayments rather than at the start of your postsecondary education.

For private loans, the repayment period can begin as soon as you take out your loan if you don’t enroll in deferment while you are in school.

Origination fee

Federal student loans and many private student loans have origination fees, which are an additional cost for processing your loan. You never have to pay an origination fee directly — it will be deducted from the amount you borrow.

For instance, if you borrow $10,000 with a 5 percent origination fee, the final amount you receive will be $9,500. However, you will still need to pay interest on the full $10,000 you agreed to borrow.

Private vs. federal student loans

Private student loans are offered by private lenders, while federal student loans are provided by the U.S. Department of Education. There are many differences between private and federal student loans.

For example, while all private loans require a credit check, most federal student loans don’t. Also, private loans generally don’t come with certain benefits — including access to income-driven repayment plans and student loan forgiveness — and their deferment and forbearance programs may not be as generous.

Federal loan interest rates are standardized and fixed, which means they’re the same for everyone who qualifies and won’t change over the life of the loan. With private loans, your rate depends on your creditworthiness. You may also have the choice between fixed and variable rates. If you choose a variable rate, your interest rate is subject to change.

Simple and compound interest

Simple interest is the process of calculating interest based on unpaid principal. With compound interest, the interest you owe is calculated on both the unpaid principal and any unpaid interest that has accrued that month. This makes compound loans significantly more expensive for borrowers.

All federal student loans use simple interest, and many private student loans also use simple interest. As a borrower, you should be on the lookout for simple interest because it will cost you less. Since it is the most common method for calculating interest, you will likely be able to find a lender that uses simple interest calculation if your federal student loans aren’t enough to cover your education costs.

Student loan consolidation

In general terms, debt consolidation is similar to refinancing — the process involves paying off one or more loans or credit cards with a new loan. Student loan consolidation may refer to private student loan refinancing, but it is more commonly used to describe the federal Direct Loan Consolidation program.

This program allows borrowers to replace one or more federal student loans with one new one. Depending on the type of loans you have, Direct Loan Consolidation could help you qualify for certain repayment plans, qualify for student loan forgiveness or get your loans out of default. However, it does not allow you to get a lower interest rate as refinancing often does.

Student loan deferment vs. forbearance

Student loan deferment and forbearance both allow you to postpone payments for a predetermined period of time, but there are a few differences. If you have subsidized loans, interest will accrue during forbearance but not deferment.

Deferment options are typically more generous as far as who qualifies and how long you can pause your payments. Deferment and forbearance are generally offered by both federal student loan servicers and private student lenders, but eligibility requirements and terms can vary.

Student loan forgiveness

Certain student loan borrowers with federal loans may qualify for student loan forgiveness programs. There are several ways to have some or all of your student loans forgiven, but they typically don’t apply to private loans.

Most forgiveness programs are occupation-based and require years of qualifying payments prior to forgiveness. If you’ve recently graduated or are graduating soon, look into the various federal student loan forgiveness programs to see if you meet the application criteria.

Student loan refinancing

Student loan refinancing is the process of replacing one or more existing loans with one new one through a private lender. If you’re eligible, refinancing your loans could allow you to get a lower interest rate and monthly payment, have flexibility with your repayment schedule and choose a different lender.

Refinancing student loans isn’t for everyone, though, It can be challenging to qualify if you don’t have a strong credit history or high income. If you refinance your federal student loans, you forfeit your federal benefits and protections.

Student loan servicer

If you have federal student loans, the money you receive is from the federal government, but your student loan servicer is the private company that manages your account and collects payments. You generally don’t get to pick your servicer when you first apply for federal student loans, but you can if you consolidate them later on.

To find out who your federal servicer is, visit your FSA dashboard on the Federal Student Aid website by logging in with your FSA ID.

Unsubsidized vs. subsidized loans

Federal subsidized student loans are designed for undergraduate college students who demonstrate financial need. With these loans, the federal government pays your interest while you’re in school at least half time, for the first six months after you graduate and during any future deferment periods.

Unsubsidized loans, on the other hand, function like other traditional student loans. Interest accrues whether or not you’re making payments, including while you are in school, and you’re responsible for paying it once the six-month deferment period after you graduate is over.