Student Loan

What It Means

A student loan is a sum of money made available to a student who is pursuing higher education, such as college or university study. Because higher education costs tend to be expensive, and because few students are able to work a full-time job while going to school, student loans provide a valuable form of financial assistance. Student loans are designed to help students pay for such expenses as tuition (the basic cost of attending school), student fees (book purchases, library fees, and athletic charges, for example), and room and board (housing and meals). In general, student loans cater to those students who are in need of financial assistance, though many student loans are available to any student who applies for them, regardless of his or her financial situation. Student loans fall under the general category of financial aid, along with scholarships and grants. Scholarships and grants are typically made available to students based on academic or athletic achievement or financial need. Unlike these forms of financial assistance, student loans must be repaid.

Almost all loans require the person borrowing the money (the borrower) to pay interest on the loan. Interest is a percentage of the loan amount that the borrower must pay in addition to repaying the loan. Student loans also require the borrower to pay interest on the money he or she borrows, though the interest rates on student loans tend to be lower than interest rates on other loans. Students who receive a student loan are not required to repay the loan until they have either finished their education or are no longer enrolled as a full-time student. In most cases, student loans allow students a grace period (a period during which a person is not required to meet an obligation) after they leave school, during which time they are not required to make payments on the loan. Grace periods on student loans generally span from 6 to 12 months.

When Did It Begin?

In the United States student loans originated out of the federal government’s desire to provide higher-education opportunities to a broader portion of the population. The earliest form of government assistance for higher education was created by the Morrill Land Grant Act of 1862. Under this law, the government gave federal land to individual states. The states then sold the land and used the proceeds to form colleges. These colleges were primarily designed to promote the study of agriculture and engineering.

The first student loan programs were created in 1958 with the passage of the National Defense Education Act (NDEA). Congress passed the NDEA in response to the October 4, 1957, launch of the Sputnik space satellite by the Soviet Union (a confederation of socialist nations also known as the Union of Soviet Socialist Republics, or USSR). Because the Soviet Union was believed to pose a military threat to the United States, Congress believed that creating educational opportunities, specifically in the fields of mathematics and science, was vital to national security. To help make higher education financially feasible for more students, the law included a provision for the establishment of the National Defense Student Loan Program. These early student loans were designated solely for highly qualified students and were intended exclusively for the study of science, math, and foreign languages. This program later became known as the Federal Perkins Student Loan Program. With the passage of the Higher Education Act of 1965, student loans became available to a wider range of students, and loans were offered in all fields of study. By the early twenty-first century, more than 600,000 students in the United States were receiving federally guaranteed student loans each year.

More Detailed Information

Student loans come in two basic types: subsidized and unsubsidized. In the case of subsidized student loans, the federal government will pay the interest on the loan while the student is still enrolled in school. For example, say an undergraduate college student takes out a student loan of $8,000 over a four-year period. If the loan accrues $2,000 in interest over the course of four years, the student will only owe $8,000 when he or she graduates. However, as soon as the student begins to pay off the loan (generally within six months of leaving school), he or she will begin paying interest on the loan. Subsidized loans are designed to offset the financial difficulties involved in pursuing a higher education. In the case of unsubsidized loans, the student is responsible for both the total loan amount and the interest accrued during his or her years in school. For example, if a student takes out a loan for $8,000 and $2,000 in interest accrues over the course of his or her years in school, then the student will owe $10,000 at the time he or she begins to pay off the loan. This practice of adding the interest to the amount of the loan is known as capitalization. Furthermore, as the student pays off the $10,000, additional interest will accrue on whatever amount is remaining on the loan until the loan is paid off completely.

A large number of student loans are guaranteed by the federal government. This means that the government subsidizes the loan while the student is in school, pays any expenses involved with managing the loan, and takes responsibility for repaying the loan in the event that the student defaults (fails to repay the loan). There are two principal types of federal student loans, each catering to a specific type of student. Perkins Loans cater to students with the greatest level of financial need; these loans are subsidized, have low interest rates, and have grace periods of nine months. The repayment schedule for Perkins Loans generally lasts 10 years. Stafford Loans, on the other hand, are available to all students and are the most popular form of federal student loan. Like Perkins Loans, Stafford Loans offer low interest rates (though slightly higher than rates on Perkins Loans) and are often subsidized. The repayment terms of Stafford Loans, however, tend to be longer; in some cases a graduate might take up to 30 years to repay a Stafford Loan completely.

In addition to federally guaranteed loans, there are many private lenders who provide student loans. Private student loans are unsubsidized, have a higher interest rate than federal student loans, and often require the student to pay an origination fee on the loan (a one-time charge for receiving the loan, which is deducted from the loan amount the student receives). The main advantage of private student loans is that they generally offer a higher maximum loan amount than that of federal loans.

Some students have difficulty repaying their student loans after they leave school. In many cases, these students can request that they be allowed to defer the repayment of the loan temporarily by applying for hardship forbearance. Hardship forbearance provides former students with the opportunity to skip student loan payments in times of financial difficulty, often for periods of six months. In some cases, students may reapply for hardship forbearance in extreme circumstances; for example, if they are unemployed or injured and unable to work. While all federal loans provide borrowers with the option to defer payment of the loan, some private loans do not.

In some cases, students can have their loans decreased, or even cancelled, if they agree to enter a certain line of work after they leave school. This option is usually available to students who perform volunteer work (for example, helping build houses for the poor), who serve in the military, or who take teaching jobs in low-income communities. This practice of waiving loan payments is known as loan forgiveness.

Recent Trends

In the 1990s the number of lenders offering federally guaranteed student loans rose dramatically. As competition for the student-loan market increased, lenders began to offer incentives to financial-aid administrators (officials who are responsible for providing students with information about financial aid options) so that administrators would recommend lenders’ loan products to students. These incentives took the form of gifts, stock (shares in the lending company), and sometimes cash payments. As lawmakers learned about these practices, they began to demand tighter restrictions on the way that student loan companies offered their products to students. In June 2007 the U.S. Department of Education implemented new rules concerning the $85-billion-a-year student loan industry. For example, admission officials were required to list the names of three possible lenders when offering financial aid information to students, and many gifts and incentives were outlawed.