Common Loan Terms

Here we explain a few loan concepts that you should understand. Many of these terms may be familiar to you, and if so, you may move ahead quickly. But please make sure you understand them thoroughly before continuing.

And yes, there will be a quiz!

Subsidized vs. Unsubsidized Loans

You have probably heard of Subsidized loans and Unsubsidized loans, but do you know what a subsidy is? A subsidy is financial assistance that is granted by the government that covers accruing interest.

When a subsidy exists on a loan, no interest accumulates during specific times: while in-school, during a grace period, or in a qualifying deferment. Subsidized loans are very beneficial to you, so you want to maximize your subsidized borrowing before turning to unsubsidized loans.

Subsidized loans include Subsidized Stafford Loans, Federal Perkins loans, Primary Care loans, Loans for Disadvantaged Students (LDS), some Institutional loans and possibly a portion of a Consolidation loan (depending on the underlying loan type).

Alternatively, Unsubsidized loans accrue interest from the date of disbursement. You may not actually be paying the interest while you are in school, but it is accruing and you will be responsible for it when repayment begins. Unsubsidized loans include Unsubsidized Stafford loans, Direct PLUS loans, private loans, some Institutional loans and possibly a portion of the Consolidation loan (depending on the underlying loan type).

Interest Rates

The Interest Rate is what the lender charges you to use their money – the price tag for the loan. Review the chart below, and notice that currently all Stafford loans for graduate students are at a fixed 6.8% and Direct PLUS loans are disbursed at a fixed 7.9%. Perkins, PCL and LDS loans have a low fixed interest rate of 5%. Private loans usually have higher interest rates. Institutional loan rates depend on the institution, so check with your financial aid office.

Finally, if there is a consolidation loan in your student loan portfolio, the rate will be dependent on when you received the consolidation loan and what loans you included in the consolidation.

The interest rate of these assorted loans is different so be aware when borrowing. For example, it would not make sense to take out a Direct PLUS loan at 7.9% if you are able to borrow a Stafford loan at 6.8%. Borrowing wisely is important so we will cover this topic in the next section.

How Interest Accrues

For loans that are subsidized, this accrued interest will also be your responsibility if the subsidy is not available (meaning if your loans are not in a qualifying deferment or grace period). For loans that are not subsidized, interest begins to accrue on the loan as soon as it is disbursed, and you (the borrower) are responsible to repay this accrued interest as well as the principal.

Student loans are simple interest loans and therefore the interest that accrues is based only on the principal balance of the loan. The total amount of interest to be paid is not a pre-determined amount because the borrower has the right to repay and prepay as aggressively as they prefer.

The cost of the loan is ultimately dependent on the term utilized by the borrower (said another way, the amount of interest that accrues on student loans depends on how long it takes the borrower to pay off the principal balance in full). To a large degree, you are in control of your total interest costs.

As a federal student loan borrower, you always have the option to pay interest on Unsubsidized Stafford and Direct PLUS loans – even while you are enrolled. Work with your lender to determine the best way to send in voluntary interest payments if that is something you and/or your family choose to do.

Capitalization

At certain points in time, the unpaid accrued interest will Capitalize. Capitalization is a cost of student loans that is invisible, but the impact is significant. Capitalization can increase the cost of your loans because it takes all accumulated interest that is unpaid (from loans such as your unsubsidized Stafford and Direct PLUS loans) and makes it a part of the original principal balance. Once capitalization occurs, your new (and larger) principal balance begins accruing interest. In effect, your interest is now accruing interest.

Each lender has their own capitalization policies, so you will need to check with your lender to know when your unsubsidized loans capitalize. Typically, while in an in-school deferment, no capitalization will occur

Obviously, capitalization is not a positive process, and the less often it happens, the better.

The median balance of debt for the Class of 2009 was $160,000. For a medical student that took out $160,000 during medical school, they likely accrued $21,000 of interest (during 4 years of medical school and 6-months of grace). When this interest capitalized, the loans had a new, higher principal balance of $181,000, and the interest now accrued based on this higher balance.