What is Negative Amortization: And How Does It Affect Your Student Loan?
Negative amortization occurs whenever the amount you pay for a loan is less than the interest charged during that period. When that happens, your outstanding balance actually increases. That’s why you can start out owing $20,000 in student loans, and wind up owing $50,000 or more.
Negative Amortization While You’re In School
When you’re a full-time student, you’re usually not expected to start paying back your student loans on graduation. It sounds like a good thing—but in many cases it’s not. That’s because many types of student loans—both federal and private—do accumulate interest during that time, while you’re not paying. Because you’re paying nothing, you’re giving your interest years to accumulate—meaning your student loan bill is going to be much larger when you graduate than it was when you signed up for your loan.
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There are many types of federal student loans—Perkins loans, Stafford loans, PLUS loans—but in a way, there are really only two types: subsidized and unsubsidized. With the subsidized loan, the government pays the interest while you’re in school—so you don’t have a negative amortization problem. With an unsubsidized loan, nobody pays the interest—except you, when you graduate.
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Here’s a breakdown of which types of loans are subsidized and which are unsubsidized:
Perkins loans are all subsidized, but there are limits to how much you can borrow under this program. As an undergraduate, you can borrow up to $5,500 a year, or $27,500 over the lifetime of your college career. As a graduate student, you can borrow as much as $60,000, but that includes what you borrowed as an undergrad. You also have to qualify for a Perkins loan by demonstrating exceptional financial need.
Stafford loans can be either subsidized or unsubsidized. Anyone can take out an unsubsidized Stafford loan, but you must demonstrate financial need to qualify for the subsidized version. There’s also a limit to how much you can borrow under the subsidized conditions, which varies depending on your financial need.
PLUS loans are unsubsidized. Anyone can take out a PLUS loan, including parents of students to pay for a child’s tuition, as long as you have decent credit.
Private student loans are always unsubsidized. Still, a PLUS loan is usually better because the interest rate can often be about half what a private loan rate is, and it isn’t variable—so it won’t change without notice.
It’s important to note that as of July 1, 2012, graduate students are no longer eligible to take out subsidized Stafford loans. They can still qualify for Perkins loans, however; but only a small fraction of students who can demonstrate extreme financial need qualify.
See Also: Understanding Student Loans
Negative Amortization While Your Loan is Deferred
If you’re experiencing extreme financial hardship after you graduate, you may qualify to get your federal loans deferred. This means payment will no longer be due until your financial situation improves.
During this period, however, your interest will continue to add up—even for loans that were formerly unsubsidized. This means that at the end of your deferment period, you’ll owe more than you did when you started—sometimes a lot more. When you have to start repaying again, your loan payments will be much larger than before.
If you were lucky enough to find a well-paying job in the meantime, this might be a manageable situation. But if you weren’t, a deferment could ultimately make your financial situation worse. Because of this, many financial advisors suggest deferment only when your financial situation is likely to be challenging in the short term—and you have a well-paying job in sight at the end.
If you have an unsubsidized loan to pay for tuition at a traditional or accredited online school, the best solution is often to make payments on at least the interest while you’re in school. If you do, that will keep your interest from inflating the loan. It might be difficult to find the money to pay down the interest while you’re in school full time—but the payoff can be worth it.
Sources
FinAid.org: Negative Amortization
StudentAid.Ed.Gov: Subsidized and Unsubsidized Loans
FinAid.org: Student Loans
More About Understanding Student Loans
- Credit Repair Services You Should Never Pay For
- Questions You Should Ask Before Applying for Student Loan Forbearance
- The Bank on Students Act: What It Is, and How It Could Help Student Borrowers
- How the Death of a Co-Signer Can Affect Your Student Loan
- Peer-to-Peer Student Loans: What They Are, and How They Can Help You Pay for College
- If You're Unable to Work Because of a Disability: What Happens to Your Student Loan?
- New Rules for Debt Collectors: How They Could Affect Your Student Loan
- Having Trouble Repaying Loans? The Department of Education May Be in Touch
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