Understanding How Student Loans Work: A Practical Guide for Families
Why Student Debt Matters From Day 1
Many students and parents view student loans as something to worry about “down the road.” The reality is that student debt affects financial health immediately upon borrowing, not just after graduation. Understanding how student loans work can help families make more informed financial decisions and avoid years—or even decades—of financial strain.
Key Realities of Student Loans
It’s not just “student debt.” Most loans require adult co-signers, making it a student & parent debt.
Interest starts accumulating right away on unsubsidized loans, often increasing the total loan amount by 20%-40% before graduation.
Many students take longer than 4 years to graduate. Since grants and scholarships often cover only four years, additional years mean more borrowing and higher total debt.
The average monthly take-home pay for college graduates is around $3,200. After covering essential expenses, there is little left to manage loan payments comfortably.
Many students refinance their loans for 20-30 years, which lowers their monthly payments but dramatically increases the amount of interest paid over time.
How Much Should You Borrow?
Financial experts recommend borrowing no more than 50%-80% of your expected first-year salary upon graduation. Ideally, total debt should stay below 100% of expected first-year salary to avoid financial distress.
For example, if a student anticipates earning $50,000 annually after graduation, the recommended total borrowing amount over four years should be under $25,000. However, the average student debt upon graduation is over $30,000, making it essential to plan wisely.
Two Approaches to Student Debt: A Tale of Two Students
Kevin – Prestige Over Practicality
Kevin’s family prioritized prestige over affordability. Although Kevin was an average student, they pursued a top-ranked school that offered little financial aid. Over 5.5 years, Kevin and his parents borrowed over $150,000, deferring payments until after graduation. With interest added, their total debt exceeded $200,000, resulting in monthly payments over $1,000. Both Kevin and his family struggled. His family had to sell their business in order to afford their loans. Kevin refinanced for 30 years, increasing total interest payments by $15,000—and realized he'd still be repaying loans while his own children were preparing for college.
Jayden – Balancing Prestige and Affordability
Jayden’s family originally pursued top-ranked schools but reconsidered after seeing projected loan amounts. Instead, they found a well-regarded but more affordable school. With strategic planning, Jayden graduated in 4.5 years with $85,000 in student debt. They made payments while in school and avoided excessive refinancing, significantly reducing long-term debt burdens.
Cogi InSights: Smart Borrowing Strategies
Make interest payments while in school. Even small payments can prevent interest from capitalizing, reducing overall debt by 30%-50%.
Borrow as little as possible—preferably no more than your expected starting salary.
Manage expectations about post-college financial realities. New graduates should prepare for frugal living, budgeting, and shared housing to minimize financial strain.
Prioritize affordability over prestige. Brand-name schools do not always offer a better return on investment (ROI), and students who know how to college can get a top-notch education from just about anywhere.
Types of Student Loans: Federal vs. Private
Federal Student Loans (Most Common and Flexible Option)
Federal loans are funded by the U.S. government and offer fixed interest rates, income-driven repayment plans, and loan forgiveness options in certain circumstances.
Two Main Types of Federal Direct Loans:
Subsidized Loans: The government pays interest while the student is in school or during deferment periods. These loans are available only to undergraduates with financial need.
Unsubsidized Loans: Interest begins accruing immediately upon disbursement. Students are responsible for all interest costs, though payment can be deferred until after graduation.
Current Federal Loan Limits:
1st Year: $5,500 total; up to $3,500 subsidized.
2nd Year: $6,500 total; up to $4,500 subsidized.
3rd & 4th Years: $7,500 total; up to $5,500 subsidized.
Maximum Undergraduate Limit: $31,000 total; up to $23,000 in subsidized loans.
Federal PLUS Loans (For Parents & Graduate Students)
Parents can borrow up to the Cost of Attendance (COA) minus all other aid received.
Requires a credit check—if adverse credit history exists, a co-signer or additional documentation is required.
Higher interest rates than Direct Loans but still more flexible than private loans.
Private Loans: Higher Costs, Less Flexibility
Private loans are funded by banks, credit unions, or other lenders and often come with variable interest rates and stricter repayment terms.
No federal forgiveness programs
Limited deferment and repayment flexibility
Interest rates based on creditworthiness
May offer lower rates for borrowers with strong credit or a co-signer
How Student Loan Interest & Repayment Work
Nearly all student loans allow deferred payments while the student is in school. However, interest continues accruing unless it is a subsidized loan.
Common Loan Repayment Options:
Standard Repayment Plan: Fixed payments over 10 years.
Graduated Repayment Plan: Lower payments at first, increasing every two years.
Income-Driven Repayment Plans (IDR): Payments based on a percentage of discretionary income, with forgiveness options after 20-25 years.
Extended Repayment Plan: Up to 25 years of payments with lower monthly amounts.
Many borrowers refinance their loans for lower payments, but this often extends the repayment period and increases total interest paid over time.
NOTE:
Recent executive orders have introduced changes to federal student loan programs, impacting income-driven repayment plans and Public Service Loan Forgiveness (PSLF). These adjustments may affect borrowers' repayment options and eligibility for forgiveness.
Key Changes:
Income-Driven Repayment Plans: While these plans are still available, applications for them have been suspended, limiting access to lower monthly payments for some borrowers.
Public Service Loan Forgiveness (PSLF): Eligibility criteria have been tightened, excluding certain organizations from qualifying as public service employers.
Considerations for Borrowers:
Stay Informed: Regularly check official updates from the Department of Education to understand how these changes may affect your repayment strategy.
Evaluate Repayment Options: Assess your current repayment plan and explore alternatives if your eligibility for forgiveness programs has changed.
Seek Professional Advice: Consult with a financial advisor or student loan expert to navigate these changes effectively.
Cogi InSights:
If you want to be smart about loan/debt management, consider doing these things:
Limit total student debt to 80% of expected salary.
Start making interest payments in school whenever possible.
Take out smaller loans earlier and reserve larger borrowing for later years to minimize interest costs.
Understand repayment options before borrowing.
Explore loan forgiveness programs if entering public service fields.
By staying proactive and informed, as well as understanding student loans before borrowing, families can make strategic and adaptive choices that reduce debt burdens and improve long-term financial stability. If you need personalized guidance on planning for college costs, reach out—we’re here to help!