Everybody knows that student loans are not free money – they come at a price. Unfortunately, many students underestimate exactly what that price is. There are interest and fees and sometimes even penalties. All in all, student loans cost more than just the principal balance. Let’s break it down.
The True Cost of Student Loans
Let’s say you borrow $10,000 by way of student loans. When it’s time to repay the loan amount, you’ll have to pay much more than $10,000. Here’s an overview of the various fees and charges that add to the cost of your student loans.
Origination Fees – Many lenders charge a fee for processing student loans. This may be called origination or processing fees. This fee usually ranges from about 1% to 5% of the loan amount. Some lenders may also charge additional fees for stamp duties and various other documents.
Loan Modification Charges – Your circumstances may change after taking a loan and you may want to change the terms of your loan. You may want to extend or reduce the loan term or you want to swap cosigners. Most lenders will charge you to make any loan modifications as it involves extra work for them.
Interest – You cannot talk about the cost of student loans without mentioning interest. By the time you clear your debt completely, the amount you will pay by way of interest is staggering. And this is not just simple interest either. If your $10,000 student loan comes with a 7.5% fixed interest rate, you won’t just be paying 7.5% of $10,000. For every month, you will pay 7.5% of the loan amount that is outstanding that month. Needless to say, the interest can add up to a substantial amount.
Penalties – Every late payment or bounced check attracts a penalty. Making multiple late penalties can add to the cost of your student loan.
Pre-payment Charges – Have extra funds and want to pay off your loan early? Very few lenders will allow you to do this without paying a pre-payment fee. This is because when you pre-pay they’re losing out on the interest you’d otherwise pay for the full term.
It’s most important to read all loan documents carefully and double-check the terms and conditions before signing any contract. Many times, fees are hidden in the fine print.
How to Lower the Overall Cost of Student Loans
There are a few things you can do to reduce the overall cost of your student loans.
Sign up for automatic payments – Most lenders will give you a 0.25% interest rate reduction if you set up auto-payments. This involves asking your bank to transfer the monthly payments directly from your account to the lender’s account. You set the date for the recurring transfers a few days before the due date. Setting up auto-pay assures lenders that they will get their monthly payments on time every time. As an incentive, they offer a discount on the rate. While it may not sound like much, it does help to lower the overall cost of your student loan. Another benefit of auto-pay is that it minimizes the risk of you missing a payment, which can have serious consequences.
Choose a shorter repayment term – When you take a student loan, most lenders will allow you to choose a loan term. The loan term is the time you take to repay the loan. Choosing a shorter repayment term spreads the monthly payments over a shorter time period. This reduces the overall interest that accrues. However, this will involve making higher monthly payments. The key is to figure out how much you can afford to pay every month and pay as much as you can. This will lower the cost of your student loan considerably.
Make payments while you’re in school – Student loans come with a grace period that extends up to about six months after your graduation day. You are not expected to make any payments during this grace period. However, the interest on the loan starts accruing from the day you receive the money. It goes on accruing right through the grace period. When the grace period ends and your loan enters repayment, any unpaid interest is capitalized. This means it gets added to your original loan balance.
Paying off a small amount every month while you’re still in college can help reduce the cost of your loan. Even if you can only make payments of $25 – $30 a month, it’s still better than not making any payments at all.
Make additional payments – Putting all your cash gifts towards paying down your loan is another way to lower its cost. Received a generous cash gift for Christmas or your birthday? Resist the urge to splurge and make an additional payment on your student loan instead. It’s important to put this towards the principal and not the interest. A smaller principal amount accrues less interest, reducing the overall cost of your student loan.
Refinance your student loans – Refinancing is when you exchange your high-interest loans for a new loan at a lower rate. This is a great way to lower the cost of your loan. It only works if your financial history and credit score have improved since you graduated. It helps to know how to build credit fast and work towards it from the outset.
Student Loans Cost More Than Just The Principal Balance
Doing any one or two of the above tips will help to lower the cost of your student loans. Combining all the tips will help you save the most money. As you can see, none of these is particularly difficult to do.
If you’re getting a student loan, it’s vital to find one that fits your specific needs. Luckily College Raptor’s free Student Loan Finder can do just that!