Student Loans: Basic Definitions

Welcome back, associates. We're going to start by talking about that. Some of the basic definitions of student loans and even loans in general a little bit at a very high level. There are really two types. Now, there's a couple more, but there's really two types of student. Student loans. There are indirect loans and there are direct loans. And let's first talk about indirect loans. Indirect loans are also known as guaranteed loans. And there are really one main type of these. These are called. They were called Federal Family education loans, or FFEL loans. The thing is, is that these loans didn't even exist or haven't existed since 2010. Before that, most of the loans were fell loans. And these guaranteed loans were loans issued by banks, not the federal government, and they were backed by the federal government. The government said, we're gonna let banks finance these loans and we're just gonna guarantee them for students. That way banks feel comfortable lending large amounts of money to, to people who don't even have income. Well, in 2010, the government said, whoa, whoa, whoa, banks, you're charging too much. We don't like the way you're administering these loans. So we are going to lend directly to students from here on out. And they did completely away with indirect loans or these guaranteed loans, which now takes us to direct loans. And direct loans are any loans you get directly from the federal government and. Or specifically the Department of Education. Now, the government said, we'll lend, but we're not going to deal with the administration of this. We don't want to worry about collecting and following up with borrowers who aren't paying and all that stuff. So we're going to outsource that. We're going to have that done by a loan servicer. And you probably already heard of this term before, because if you have student loans, which most of you do, they're being serviced by a loan servicer. And we're going to talk about those here in just a moment.

Now, these loans, these direct loans, can be either subsidized or they can be unsubsidized. Subsidized loans are only available for undergraduate students, and most of you are not undergraduate students. So you probably have or may have some subsidized loans because you took out some loans in your undergraduate degree and those are subsidized. What subsidized means is that the government will pay for the interest on those loans while you're finishing up school, so the balance stays the same. Except for, of course, when you take on new debt, new student loans with each subsequent Year, freshman, sophomore, junior, senior. But the government will pay for the interest on those loans. They say you don't have to pay interest, they pay for it. I mean they lent you the money. So really they're simply not charging you interest on those years while you're still in school. For subsidized loans. Again, only applicable for undergraduates. Now let's get to the relevant ones for you, the big ones. Those are your subsidies. Unsubsidized loans, graduate direct loans. Now these loans are also issued directly from the government, but interest does accrue on these while you're still doing your graduate studies. The same applies if you're doing a residency as well. The government simply says you don't have to pay that interest though while you're still in school. But when you get out, the interest that accrued that was charged during your graduate and if you do residency, residency years, that gets added to the balance of your loan. Really important subject. On that note, we're going to talk about what is the difference between accrued interest and capitalized interest. They're related but very different and a really important subject for you to understand about your student loans. So at the highest level we got indirect loans and we have direct loans. Under direct loans, we have subsidized loans and we have unsubsidized loans.

Now I want to talk about the basics of debt repayment. This is going to apply whether it's debt on a car, whether it's a debt on your house, or whether it's a debt on your student education.

When you take out a debt, now this is debt 101. But still this is important. You know why? Because you're going to be dealing or you're going to be taking on a lot of debt in your life. It's not just your student loans. That's just the start. You're going to take on debt for your practice. You're going to take on debt to buy equipment, maybe you buy a new CAD cam or a ct. You're going to take on debt to possibly do a build out in your office, maybe to buy your building, to buy your home. There's a lot of reasons why you're going to take out debt. This is why it's so important to manage your credit score, which we have a module on that as you're a student and coming out in an early career dentist, really important to manage that credit score. So let's talk about debt. Let's look at an example. In debt you have a few basic features. Number one, you have the balance of the debt. How much did the bank, or in this case the federal government, how much did they lend you? In this example, $500,000.

Now, the rate is the rate of interest that you pay on that debt. So in a year that you have $500,000, you may pay $25,000 of interest on that debt and the principal does not go down. That's purely paying somebody for having lent you money. You will also have the term. The term is how long before that debt is finally paid off. A simple example might be five years. Now, student loans, when you come out of school, the default is 10 years, and we'll talk about that in a subsequent module. The start date of a loan is the fourth feature. When does that loan start? Now, speaking of rates, look at what in the rates are right now. As of 2020. I'm speaking to you in May of 2020. So these will change from year to year and you can see these on studentaid.gov. but as of right now, you have direct subsidized loans and direct unsubsidized loans for undergraduates. Yeah, I didn't mention this earlier, but yes, if you're an undergraduate and you max your subsidized loans, you could end up getting unsubsidized loans as well. But if you're an undergraduate, that's at a modest rate, 4.53. Not too bad now for you graduate students, for those of you in dental school or beyond in say, a residency, if you need to take out more loans in residency, perhaps you don't, then your rates are at 6.08%. So not low, not terribly high, somewhere in between. And we're in a very interesting period right now with interest rates being virtually nothing. We've just gone through the coronavirus era and banks are sort of in a very nuanced position right now. It'll be interesting to see where interest rates go here over the next two, three, four years. But right now, as it stands, it's 6.08% on your direct unsubsidized loans. Now, you probably took out loans before, as you can see in our chart, July 1, 2019. So you may have had rates at different levels for your specific loans and for the different tranches of loans that you took out. Might even have different rates as well. And then if you didn't couldn't get enough loan from the direct unsubsidized loans, then maybe you had to take out the direction plus loan. And these are parent and graduate for professional students. That's at the highest at 7.8. Now you're starting to talk about a pretty high interest rate, north of 7%. So those are the basic repayment details or the basic features of a loan and what the rates are right now for the student loans. Let's look at an example of a specific debt. 500,000 at an interest rate of 6.08% for 10 years. 10 times 12 months is 120 months. Typically when you're dealing with loans you talk in terms of months. So 10 years, 120 months and your payment start date January 2021. Let's look at this thing called an amortization table. I want you to understand what an amortization table is. They don't teach this to you in dental school and you probably never heard of an amortization table. But it's really important because you're going to be, you're going to be paying on amortization tables for a very long time. So let's at least understand it. An amortization table is period by period, the allocation of your payment on that loan toward principal and interest. Let me say that again. It's the allocation, period after period of your payment toward principal and interest. Principal pays down the debt, interest pays the lender for having given you money to accomplish something. And notice in the year 2021 that your total payments were on the right hand side top right, $66,800 $854. And that was split between principal of $37,487 and.

Interest of $29,367. That's a lot of money going toward to the bank. Almost $30,000 for that year, for that's $2,500 a month pretty much for having lent you that money. Well, that's how banks thrive. That's how banks make their income. And they're very good at that. Of course, now in this case it's actually the federal government is making some income off of you. Although there's many subsidies that the federal government is going to provide you, which we're going to talk all about those that a private bank won't do. But this is, this amortization schedule is standard for every, for almost every type of loan you get. Now there's some interest only loans and some nuanced loans out there. But this is the basics of most loans. Your home loan, typically a car loan, your equipment loan, the practice purchase loan, buying your building. This is how it works. And so when you go to the second year though or maybe the second month, assuming your payments are monthly. I'm keeping this simple. And we're looking at it from a year by year basis. But if you look at it monthly, I mean, if you look at it here, on the second payment, which is 2022, notice that your principal payment goes where.

It goes up and your interest payment goes where it goes down, and your total payment stays the same. And if you go to 2023 further, your principal goes up and your interest goes down. And so every year you're paying more principal and less interest until you get to your last payment in 2030. And almost all of your payments went toward principal. Very little went toward interest. Well, who does this sort of schedule, this shifting, who does it benefit? It benefits the bank. Why? Because the bank wants to get paid early on. They reduce their risk by being paid larger amounts early on. And you really don't see significant reductions in your loan until you get farther down the amortization schedule, because so much of your payments are going toward interest in those early years. So I had a dental student email me yesterday asking how it would affect their loan if they made extra payments on their student loans. Well, whenever you make extra payments, it's going to go toward the principal. Now that's a good thing. We want that going toward the principal. Whenever you make an extra payment, it goes toward the principal. And if it goes toward the principal in the next payment, that interest rate is a function of the outstanding balance. So on the next payment, you actually have more going toward principal than there would have been had you not made that extra payment beforehand. So extra payments are an excellent way to accelerate getting out of debt and your interest. You can save a lot in interest by making extra debt payments, but there's a lot more to that decision because you have to think about, in accounting term, this thing called opportunity cost. And opportunity is cost is what is the cost by not doing another option, by not following another opportunity? In other words, could you have a better overall economic benefit if you didn't apply that extra money toward your student loan debt for an extra payment? And instead you put that, for example, in the stock market or in a tax deductible 401k or you paid off some other debt or you invested in a new CT or some other equipment? What is the economic value that would come out of that other use of that surplus cash? And it's one of the most important things that successful people do is they learn how to assess their opportunity costs and then allocate their surplus money. What we call your surplus capital in the most optimized way to get the highest return back to you. And you're going to find you have many ways to allocate your money. The worst is taking extra surplus money and going and spending it on unnecessary expenses. And in your early years in your career, I'm going to tell you to avoid that at all costs. We need that to go toward building capital, building assets or paying down debt. And clients of practice CFO know one of the most important things we do in our planning meeting is we define what our surplus is and then we create a schedule of how we're going to allocate that to target specific financial planning goals. And it's amazing to see the progress in such a quick amount of time with our clients net worth. So here on the debt on the amortization schedule, really important to understand how the nature of the numbers work as you make each subsequent payment toward your student loans. Now, in a future module here, very soon we're going to talk about interest in a lot more detail, specifically accrued interest versus capitalized interest. And very important to understand how that might affect your student loans and the rate at which you will be able to get out of those student loans.