What are the four types of student loans?

[00:00:00] Ralph Estep, Jr.: Are you drowning in student loan debt? Are you wondering which type of loan is best for your future if you're getting ready to start college? Well, today we're tackling a topic that's close to many hearts and wallets and that's student loans. But before we dive in, let me ask you this question. Did you know that choosing the wrong type of student loan could cost you thousands of dollars in the long run? Well stick around today. I'm going to show you how to navigate this complex world of education financing. This is a show you don't want to miss on this financial Friday.

[00:00:35] Ralph Estep, Jr.: If you missed yesterday's show on how to prepare for an audit of your home office expenses, make sure you check it out. You can find all of our episodes at askralph.com and trust me, it's packed with tips that could save you a headache and maybe even some money down the road.

[00:00:52] Ralph Estep, Jr.: Well, let's jump right into our question. This comes to us from Ava in Oregon, and she writes this.

[00:00:56] Ralph Estep, Jr.: "Dear Ralph, I'm about to start college next fall and I'm overwhelmed by all the student loan options out there. Truth is my parents can't afford to pay for my education. So I know I need to take out some loans, but I'm scared of making a wrong choice and ended up in a financial mess. I've been reading and I see things like subsidized and unsubsidized loans, and it actually kind of gives me a headache. Can you break down the different types of student loans and help me understand which one might be the best for me? I want to honor God with my finances, even as I invest in my education. Thank you for your guidance."

[00:01:31] Ralph Estep, Jr.: Ava, thank you for your question. I can feel the weight of that decision in your words, and I want you to know that you're not alone in feeling overwhelmed. The truth is many young Christians face the same dilemma, trying to balance their educational aspirations with financial wisdom and their faith. So let's dive into this topic and hopefully bring some clarity to your situation. Before we get into the meat of today's topic, I want to remind you the whole point of my show, the Ask Ralph show is to answer your questions. So keep them coming in just as Ava today. She has a great question for us to talk about. Send in your questions to me at ralph@askralph.com or you go to our website. That's askralph.com. You'll see a microphone icon at the bottom. Just click record and tell me what's on your mind.

[00:02:15] Ralph Estep, Jr.: Welcome to today's show and thank you for tuning in. I am grateful for each one of you who takes the time to listen and engage with this content. The trust you place in me to guide you through these financial waters is something I don't take lightly, and I consider it a true honor. And if you're finding value in the show, I want to encourage you. Visit our website at askralph.com and join our community and share this episode with others who might be wrestling with student loan decisions or other financial questions. Remember this, when you join our email list you get a free copy of my book, Mastering Your Finances and that's a $10 value on Amazon, but it's your gift for being part of our community.

[00:02:54] Ralph Estep, Jr.: I always like to start things with a Bible verse. So this one doesn't specifically talk about student loans, but I want to share it with you. And I'm speaking about debt, and I've used this many times on the show. It's a good fit for today's discussion. It comes to us from Proverbs 22:7. It says this.

[00:03:10] Ralph Estep, Jr.: "The rich rule over the poor, and the borrower is slave to the lender." Now this verse isn't meant to discourage us from even borrowing but it does remind us of the weight of debt and the importance of making wise financial decisions. Ava, truth is you've taken the first step in the right direction by reaching out to me today.

[00:03:28] Ralph Estep, Jr.: So let me help you and others who are also navigating this. I'm going to call it rough terrain because it is.

[00:03:36] Ralph Estep, Jr.: Well, let me start by sharing a story that'll hit close to home for many of you. A few years ago, I had a client named Michael. Now Michael was a bright young man, full of ambition and faith. Much like our listener, Ava. Michael had just graduated from college and landed his dream job at a nonprofit organization. He was excited to start making a difference in the world. He was living out his calling to serve others. But there was a big cloud hanging over Michael's head. That cloud was a mountain of student loan debt.

[00:04:03] Ralph Estep, Jr.: You see, when Michael was choosing his student loans, he didn't fully understand the different types or their long-term implications. He'd simply taken whatever was offered, assuming all student loans were created equal. Now fast forward a little bit. Michael came into my office one day, his eyes were red from lack of sleep, his shoulders hunched over. You could see the weight of this debt on him. He said, "Ralph", he could barely even speak. He says, "I don't know what to do. I'm trying to serve God in my community, but these loan payments are crushing me. I can barely afford rent and food, let alone thinking about tithing or saving for the future. Did I make a mistake in pursuing my education?"

[00:04:40] Ralph Estep, Jr.: You know what, it's not the first time I've heard that, and my heart went out to Michael. And I knew we had some work to do. His situation was slowly suffocating him, and he had no idea what to do. I don't want this to happen to you, Ava. So let's break down the 4 types of student loans just as I did for Michael. Unfortunately, that was after the fact so I can help you understand your options and make an informed decision.

[00:05:02] Ralph Estep, Jr.: So we're going to jump right into it. The first type of loan is what's called a direct subsidized loan. Now these loans are federal loans available to undergraduate students. Notice I say, undergraduate with financial needs. So you've got to fill out that FAFSA and you've got to qualify for this. Now, the beauty of these loans, the government pays the interest on these loans while you're in school, they pay the interest during your grace period. And even if you take any deferment periods. And this makes them one of the most affordable options for students because if you think about it. The key is the government is paying the interest during these times. So it's not accruing and it's not increasing that balance of the loan while you're in school or during your grace period while you're looking for that first job after graduation or during any deferments. If you don't know, let me talk to you what a deferment is. A deferment is when you ask for the loan payments to be suspended because of your experience, some sort of financial hardship. Maybe you lost your job. You're temporarily furloughed, or you're laid off. That's going to be a topic for another show.

[00:05:53] Ralph Estep, Jr.: So moving onto the next type and it's what's called a direct unsubsidized loan. These too are federal loans available for undergraduate, and now we're opening up that graduate student thing. And these are given regardless of financial needs. So there's no qualification. Unlike the subsidized loans, interest accrues on these loans from the moment they're dispersed. And that's the key difference. They're unsubsidized because that loan starts the day they fund that loan. And if you don't pay the interest while in school, it gets added to your principal balance.

[00:06:19] Ralph Estep, Jr.: So think about it like this. You start off your freshman year with one of these unsubsidized loans. The day you get that first draw on that loan, that interest is going to start to accrue. So that loan balance is going to go up and up and up and it doesn't ever stop until it's paid off.

[00:06:33] Ralph Estep, Jr.: Now, the next type of loan we'll talk about is what's called a direct PLUS loan. Now these are federal loans available to graduate students, not undergraduate students, and parents of dependent undergraduate students. Now, the thing about these loans, these direct PLUS loans, they have a higher interest rate than subsidized loans and they require a credit check which is a big deal.

[00:06:52] Ralph Estep, Jr.: So unlike the first two loans, which did not require credit check, these loans require good credit and are those, they basically use for those seeking graduate degrees or for those parents of those undergraduate students who can't afford to pay it. You also got to recognize that these loans generally have higher interest rates and again, no subsidization. So that interest is accruing from the start and that's not a great thing.

[00:07:14] Ralph Estep, Jr.: Okay. Now let's move on to the fourth one. And that's what's called private student loans. These loans are offered by private lenders like banks or credit unions. Again, they're going to have higher interest rates and have less flexible repayment options than those federal loans. So you see, there's a trend of up in here. The federal loans are the way to go. Now these what they call private student loans also require a credit check, and you may even need a co-signer because they're going to look at your income. They're going to look and make sure you can afford to make the payments.

[00:07:41] Ralph Estep, Jr.: Now, many of you know I used to work in credit union field. We used to offer these loans to our members. They were generally for situations where students weren't able to qualify for federal loans, maybe because they had too much family income or the cost of their education exceeded those loans allowed from the government. The government will put caps on how much they're going to give you. Again. Let me remind you. These require a credit check. They have higher interest rates, and a balance increases again from the day that loan is dispersed. I'm also going to let you know that a lot of times they're going to be, you're going to have to make a monthly payment on these loans at least of the interest portion while you're in school.

[00:08:16] Ralph Estep, Jr.: So those are really the big 4 types. So Ava, you might be asking, why are some types better than others? And I kind of alluded to this. Well, it comes down to a few, a few key factors. Let me say that twice. The first one is interest rates. As I said, federal loans generally have lower fixed interest rates compared to those private loans. Those private loans aren't governed by the government. That's a funny way of saying it, but it's the truth. The next thing is repayment options. Here's a thing a lot of people don't know about. Federal loans offer more flexible repayment plans, including some income driven repayment options. What am I talking about there? There are situations where you can, you can reduce the amount you have to pay, or even have your loans forgiven, which I'm gonna talk about here in a second for these federal ones.

[00:08:57] Ralph Estep, Jr.: Well, let's jump right to it. And that's loan forgiveness. Some federal loans may be eligible for forgiveness programs, especially if you work in a public service sector. If you haven't been keeping up the news lately, you know, this is all over. This is great debate. I'm not even going to go there today. I'm gonna steer clear that whole situation. But that's what they're talking about when they talk about the president doing this loan forgiveness, these are only on federal loans. Like I said, we could debate this. The courts have said you can't do this, but it's definitely not those private loans.

[00:09:22] Ralph Estep, Jr.: Another big thing you've got to consider is subsidized versus unsubsidized, which really is a simple way of saying, does the interest accrue while you're in school or does it not? So if you've got a subsidized loan, that loan balance is not increasing, whereas that unsubsidized, man as soon as you get that money, as soon as that money is sent over to the college or university, bang, you're getting charged interest from the date. And see the thing is Ava, these differences can have a significant impact on your future repayment.

[00:09:49] Ralph Estep, Jr.: So let's look at Michael's situation. We talked about him a few minutes ago. He in his case had taken out a mix of federal and private loans, but unfortunately, he had a higher proportion of private loans. This meant he was facing higher interest rates, and he didn't have a great deal of repayment options. And I, and I go back to this. I say if Michael had understood the differences between these loan types, he might've been able to prioritize those federal ones, particularly subsidized loans if he qualified. This would have significantly reduced his overall debt burden and given him more options for managing those payments after graduation.

[00:10:21] Ralph Estep, Jr.: Well, let me talk a few minutes about some common questions I receive from clients about the tax impacts of these student loans. The first one is the main one I get. And that is, "are student loan payments tax deductible?" The answer is yes. With a little bit of a caveat, you can deduct up to $2,500 in student loan interest each year. Of course, this depends on your income. So if your income's over a certain amount, they're not going to let you take that deduction. And this applies to both federal and private student loans. It doesn't really matter.

[00:10:49] Ralph Estep, Jr.: Another question I get "is forgiven student loan debt taxable?" It depends. It's not a great answer. I know that's not the answer you wanted to hear, but it really does depend. Loan amounts forgiven under certain programs like public service loan forgiveness are not taxable, but forgiveness under income driven repayment plans may be taxable. Again, this is a whole area of discussion that's being litigated right now. The courts are getting into it. The IRS is getting into it. So this is one of the things you got to keep your eye on.

[00:11:15] Ralph Estep, Jr.: Another question I get, "can I claim the American opportunity tax credit if I have student loans?" What they're really asking in that question is, hey, if I haven't actually paid for the education, but I've incurred this student loan, you know, a liability, can I deduct? And the answer is yes, you can claim this credit for qualified education expenses paid with student loan funds. Doesn't matter whether they're for federal loans or private loans, it doesn't matter. But here's the deal you can't do. You can't claim your credit for expenses paid with tax free educational assistance. So if they're paying actual school for you and you're not getting a loan for that, then you cannot take that credit.

[00:11:51] Ralph Estep, Jr.: And the final question I get a lot is "do I need to report my student loans as income on my tax return?" Very simple answer. No, student loans are not considered taxable income when you receive them, but you got to remember this. Tax laws can change. So it's always best to consult with a tax professional like me for the most up-to-date information.

[00:12:08] Ralph Estep, Jr.: Well, let's get back to Michael's story. After we sit down and reviewed his loan portfolio, him and I came up with a plan. We consolidated his federal loans, and we got him an income driven repayment plan. Now we can only do that on the federal portion. For his private loans, we looked into refinancing options, and we were able to get a better lower interest rate by going to another institution. But beyond those practical steps, we had a heart-to-heart meeting about his calling and his finances. I reminded Michael of the parable of the talents. That's where Matthew 25. God doesn't call us to bury our talents out of fear. But he wants us to invest them wisely. His education was an investment and now it was time to steward it well. So what do we do? You know what I did. I worked with him on a budget that allowed Michael to meet his loan obligations. I showed him how to live modestly and still set aside a small amount for tithing and savings.

[00:12:57] Ralph Estep, Jr.: Maybe he wasn't giving a 10 to 20%, but he was giving something. It wasn't easy for Michael, but over time, Michael's financial stress began to lift. He was able to focus more on his work and more importantly, on his ministry, knowing he had a plan in place for his loans and that's what Michael really needed. He needed that plan. If you're in a similar situation to Michael or Ava's, here's some action steps you can take. You know I always want to give you some action items.

[00:13:20] Ralph Estep, Jr.: The first thing, this one is absolutely crucial. You got to understand your loans. You got to know what type of loans you have. Most of the people I talk to have zero clue what they have. You got to know their interest rates and you got to understand the repayment terms. That's critical.

[00:13:35] Ralph Estep, Jr.: Another thing you got to do. And I kind of alluded to this a couple of times. You got to prioritize those federal loans. If you're still in school or about to start like Ava, try to maximize those federal loan options before turning to private loans. If they continue on this crazy cycle forgiving student debt,

[00:13:48] Ralph Estep, Jr.: and like I said, that's a whole discussion for another day. You are definitely better off with the federal loans, because number one, the interest rates are lower. The repayment plans are better, and you may be able to get some of those forgiveness things.

[00:13:59] Ralph Estep, Jr.: Another thing you want to consider is income driven repayment plans. If you've got those federal loans, looking through these plans can make your payments more manageable. I've got a couple clients who work in the public sector doing like a Homeland security and things like that. One guy is actually an attorney. And if he stays working in his, in, in the location where he's working for 10 years, they'll actually forgive his loans altogether, which leads me to the next thing.

[00:14:21] Ralph Estep, Jr.: And that's you got to look into this forgiveness programs. Again, that's a great political debate, but if you're planning to work in public service or certain other fields, this is common with doctors in these small rural hospitals. Well, you might be eligible for forgiveness after certain amount of period.

[00:14:36] Ralph Estep, Jr.: And you've got to stay informed about the tax benefits. You've got to keep track of that student loan interest payments. Now, you're going to get a 1099 at the end of the year. They probably don't mail them anymore. Mostly what they do is they send you an email that says, Hey Ralph, guess what? You got a document you need to go download. So you want to keep an eye on that.

[00:14:51] Ralph Estep, Jr.: And finally, I don't stress anything else. I want to stress this. You got to seek wise counsel. Don't be afraid to reach out to financial advisors or counselors who can help you navigate these complex decisions. The schools are supposed to have people in the financial management or the financial aid office that explain all these things to you. You can also schedule an appoint with me. I'll talk about that in a minute how to do that.

[00:15:12] Ralph Estep, Jr.: So I want to just wrap up for a second. We've covered the 4 types of student loans. We talked about these are direct subsidized, direct unsubsidized, direct plus and those private student loans. We discuss why federal loans often have an advantage over private loans. I hope you've heard that. The federal loans definitely have advantages over these private loans and those types of loans as you described could have significantly impact your financial future. We also talked about some of those tax questions. Remember this. If you don't think of anything else, education is an investment in your future, but like any investment, if you listen to me, you know I say this, it needs to be managed wisely. As you make these decisions,

[00:15:47] Ralph Estep, Jr.: I want to encourage you to pray for wisdom and seek Godly counsel. I also want you to remember to tune in tomorrow. On tomorrow's show, we're going to talk about what are the specific things I should consider when buying a business. I'm going to have a whole discussion about how to not get connected to that thing emotionally, but to really look at thing with objective eyes. It's going to be another jam-packed show you don't want to miss. And hey, if you're feeling overwhelmed by your student loans or any other financial challenges, I want to help you. You can schedule an appoint with me just by going to askralphpodcast.com/store and together, we can create a plan to help you achieve financial freedom, that's the key, while honoring God with your resources. Listen, helping you is my mission field. And it drives me. It's my calling. It's my passion. You can hear it in my voice. So why don't you reach out today?

[00:16:33] Ralph Estep, Jr.: Well, thank you for tuning in to today's episode of the Ask Ralph show. Remember. With faith, with wisdom and with the right knowledge, you can master your finances and live out

[00:16:42] Ralph Estep, Jr.: God's calling on your life. So as I always say, stay financially savvy and God bless you.