Education can be paid for up front, during the education process, or after graduation. Only the very wealthy can afford to pay cash for education – the bill could reach around $60,000, or even as high as $100,000 for extended programs, like high-paid professionals. So some kind of a loan is usually in order. If the loan is made during the student’s term in school, it’s rarely paid before graduation. Some parents will mortgage their home with an equity loan to pay for their children’s education.

Promissory Note

Students having to take out loans for college will most likely have to sign a promissory note. A promissory note, also referred to as a note payable is a contract detailing the terms of a promise by one party to pay a sum of money to the other. For example, in the sale of a business, the purchase price might be a combination of an immediate cash payment and one or more promissory notes for the balance.

The terms of a note typically include the principal amount, the interest rate if any, and the maturity date Sometimes there will be provisions concerning the payee’s rights in the event of a default, which may include foreclosure of the maker’s interest. Demand promissory notes are notes that do not carry a specific maturity date, but are due on demand of the lender. Usually the lender will only give the borrower a few days notice before the payment is due. For loans between individuals, writing and signing a promissory note is often considered a good idea for tax and recordkeeping reasons.

Federal vs. Private Loans

The two main categories that student loans fall under are federal and private loans. Both types can be processed by private financial aid companies, but federal loans are guaranteed by the federal government. Because of this reduced risk, federal loans typically have lower interest rates. An interest rate is the cost of the loan, and can be a fixed or variable.

Federal Loans

Federal loans are loans guaranteed by the government at relatively low interest rates. Federal loans have strict borrowing limits, so students often need to supplement their federal loans with private loans. Knowing how the loan process works and what your options are is important in making the right judgements and decisions. Below information has been provided regarding the difference between federal and private loans, components of a loan, and repayment information.

Federal vs. Private Loans

Federal loans are often insufficient for school expenses because there are strict limits on the amount you can borrow annually, as well as cumulative lifetime limits. Also, eligibility for some federal loans is based on need, and is determined by the completion of the FAFSA (Free Application for Federal Student Aid)form.

Private Loans can cost more, but they can fill the gap between what you owe the school and what you are allowed to borrow through federal loan programs. Additionally, private loans can pay expenses that federal loans can’t, such as application and testing fees, room and board, and the cost of transportation and books. The interest rates for private loans are set individually by the companies that offer them. Federal Stafford and PLUS loans have fixed interest rates set by the federal government. It is crucial to understand that for either type of loan, students may choose the company offering them the best rates. Students are not limited to the selection provided by their financial aid office, both federal and private loans are available to all students.

Components of a Student Loan

Like all loans, student loans consist of two components, Principal and Interest. Principal is the amount borrowed, and Interest is the amount charged for lending the money. Often, a student loan also has an origination fee, which is a charge for processing and disbursing the loan.

Different loans have different interest rates. All new federal loans disbursed have fixed interest rates and origination fees. For private loans, the interest rate will depend on a variety of criteria including your credit history and your credit score. Of course, different companies may also offer different rates for their federal and private student loans. In determining your rate loan companies may take into account GPA, test scores, and program of study.

The margin of the loan can be affected by the applicant’s credit history. In general, the more risky a lender believes it is to make a loan, the higher the margin will be in order to make up for that amount of risk.

The APR, or Annual Percentage Rate, is the total measure of what a loan will cost, taking into account the principal, interest rate, origination fee if any, and the timing of all payments. The APR is often used as a way of comparing the cost of borrowing money from one lender to another. By law, a creditor must disclose the APR before issuing a loan to a borrower.

Student Loan Repayment

Student loan repayment plans vary, but there are usually three options: traditional repayment, interest-only repayment, and deferred repayment. In a traditional repayment plan, the borrower begins making payments on the principal and the interest one month after receiving the loan. This option generally has the lowest interest rate. In an interest-only repayment plan, the borrower makes payments only on the interest accumulating on the loan while they are in school. In a deferred repayment plan, the borrower defers all payments on the loan until after graduation. This option requires no payments while in school, but often has higher rates and/or fees. Also, with a deferred repayment plan, the unpaid interest is added to the principal, increasing monthly payments in a process called capitalization.

With subsidized Stafford loans, the federal government pays the interest on the loan while the borrower is enrolled in school. These loans are therefore very desirable for students; however, the subsidized Stafford is only available to those who demonstrate need as determined by the government through the Free Application for Federal Student Aid (FAFSA). Also, the amounts that can be borrowed are capped at limits below the average tuition price of American colleges. Parent PLUS loans do not have deferred repayment options; the borrower must begin paying back the loan sixty days after the funds are disbursed. Most interest-only and deferred repayment options include a grace period of six months after graduation before the interest and principal repayment begins.