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An Introduction to Student Loans

Consider these three questions. First, what is a loan? Second, how is it typically is structured? Third, do you know how much you will be paying back if you borrowed x amount? I always wished someone had personally educated me and answered these very questions.
It has been almost 20 years since I chose my college (an expensive one), and almost 10 since I made my decision to pursue a career in pharmacy (a smarter choice, but still expensive one). I consider myself fortunate because my profession (for the most part) allows me to pay back the student loan I have accumulated and still enjoy a lifestyle I had imagined.
My tuition for 4 years of pharmacy school was just a shy of $70,000; it averaged roughly around $17,500 per year. All of which I financed through a variety of student loans. Fast forward 8 years and the tuition for my alma mater has risen to $30,670 per year. Let’s think about this for second. The same degree I paid $70,000 over 4 years to obtain now costs $122,680 over the same time period. That is a 75% increase over 8 years!
But the point of this article is not to dismiss the value of professional education because of the cost associated with it. It is about providing you with knowledge that you can put it to use in your daily lives. The information provided below is intentionally generic. We can get into an in-depth conversation about student loan, but that’s for another day.
It is my hope that after you read this article, you will be able to answer the three questions I asked at the beginning of the article. If so, I believe we accomplished something.
What is a loan?
Simply, a loan is a financial agreement between a lender and a borrower on borrowing money and repaying that money. A borrower borrows money from a lender, and the borrower then repays the lender with interest.
Types of Loans
Secured vs Unsecured Loans
There are major categories of loans: secured loans and unsecured loans. The difference between these two loans is the presence of collateral.
Secured loans are guaranteed by collateral. Collateral is an asset or a property that guarantees the loan in an event of default (failure to make payments). If you default on a secured loan, the lender can take possession of the collateral. Secured loans are considered to be lower risk loans, and therefore the interest rates are generally lower than the unsecured loans. Some examples of secured loans include mortgages, home equity loans, and car loans.
Unsecured loans are not guaranteed by collateral. A lack of collateral means the lender is taking on more risk when issuing the loan. Thus, the lender will most likely charge higher interest rates for that additional risk and scrutinize your loan application. It also means that you are not likely to be approved for an unsecured loan without a solid credit history. An example of an unsecured loan is a personal loan.
Student loans are placed in a unique category. Student loans can be secured loans or unsecured loans. Federal student loans, subsidized or unsubsidized Stafford Loans, are guaranteed by the Federal Government. Therefore, for the eyes of the lenders, they can be considered secured loans. However, if you go to a private bank and get a private student loan issued by that same bank, those loans are not guaranteed by the Federal Government and therefore they are considered unsecured loans.
Federal vs Private Loans
Most student loans taken out for education are federal loans, although some people take out private loans from banks or credit unions as well. As discussed above, federal loans are guaranteed by the government and come in a few different forms:
Subsidized loans are available only to undergraduate students in limited amounts and are based on financial need. These loans have the lowest interest rate, as the interest is subsidized by the government, and generally do not accrue interest until the borrower leaves undergrad.
Unsubsidized loans have slightly higher interest rates (though still lower than most private loans) and accrue interest even when the borrower is in school. Unsubsidized loans can be taken out in larger amounts and have a higher lifetime borrowing limit. Both undergraduate and graduate or professional students may take out unsubsidized loans. Check with your school’s financial aid office, as many medical professional students are able to take out more unsubsidized loans than students in other programs.
PLUS loans are available for parents of undergraduate students and for graduate or professional students. PLUS loans have the highest interest rate among federal loans and and the borrower may not have a negative credit history. The borrower may take out any amount up to the cost of attendance minus any other financial aid received.
Federal loans are generally the better choice for students. They usually have lower interest rates than private loans, have more flexible repayment options, and—significantly—are forgiven upon death or permanent disability, meaning family members aren’t left burdened with this often significant debt burden.
Loan Structure
There are three components that make up a loan: principle, interest rate and term.
Principle is the original amount borrowed. As you make payments, the principle amount decreases. Interest is then charged on the remaining principle amount, and together they become the remaining loan balance.
Interest rate determines the amount of interest you pay on the loan. In the United States, almost all interest rates are expressed as an annual rate. APR, which stands for “Annual Percentage Rate” is the most common way the interest rates are expressed.
To fully understand how interest rates work, it is important to understand the concept of compounding period. Compounding period describes how often interest is applied to the remaining principle amount. For the majority of loans in the United States, the compounding period is one month, or 12 times a year. Remember that APR is an annual representation of the interest rate. At the start or the end of each compounding period, lenders apply interest at a fraction of annual rate that is determined by dividing the number of compounding period from the annual rate. That fractional rate is called “periodic rate”. In order to get the periodic rate, all you have to do is divide the APR by the number of compounding period in a year.
For example:
•A loan with an APR of 12% with a monthly compounding period will have a periodic rate of 1% (12% ÷ 12)
•A loan with an APR of 40% with a daily compounding period will have a periodic rate of 0.11% (40% ÷ 365)
This will become very important when we calculate loan payments later in this article.
Disclaimer: Federal Student Loans do not follow this monthly compound period rule. They follow a simple daily interest formula. The main difference is that for federal student loans, interest is applied between payments. In contrast, most consumer loans compound interest after every compounding period.
Finally, the term of a loan is length of time required to fully satisfy the loan. Most federal student loans have a 10 year term, although this may change depending on the repayment plan you choose. (Read more about repayment plan options here.) The term of private student loans will depend on the lender. On a side note, when we perform loan calculations, the term of a loan equals the total number of compounding periods occurring through the life of a loan, or number of total payments.
How to Calculate Your Loan Payment 
The easiest way to calculate your loan payments is to use various loan calculators available on the web. If you search “Loan Calculator” in Google, you will find them easily. You can also use Excel’s PMT function. (We will use the Excel method in the example below.)
Let’s do an example.
“Jane, a PY4 pharmacy student will be graduating with $200,000 in student loans. The interest rate on her loan is 6.9% APR (assume monthly compounding period). The repayment period is over 30 years. What is her monthly loan payment?”
Using the Excel PMT function will require you put in some values that are not familiar to you:
Interest Rate: Same as we talked about. Make sure you use the decimal value of a percentage.
nper (number of periods): total number of payments a.k.a. total number of compounding periods.
PV (Present Value): Current value of loan. Equal to the original principle amount.
FV (Future Value): Loan’s value at the end of the term. The loan has zero value once it is paid off, so FV is “0”.
Type: This is an optional feature. You can put “0”
The Excel Formula for Jane’s loan example would look like this: =PMT((0.069/12),360,200000,0,0).
One thing you will notice right away is that the formula will return a negative number or a number with parenthesis. It is ok. The negative number represent your money going out. Just get rid of the negative and you will have the payment amount.
Answer = $1317.20 per month for 30 years.
This is where repayment plans become significant. If Jane makes minimum payments for 30 years, she will end up paying almost 275,000 in interest on top of her $200,000 principle—more in interest than her original loan amount! Adjusting to a 10 year repayment plan, Jane will pay just over $2300 per month—$1000 per month more than the 30 year plan—but will have paid only about $75,000 in interest at the end of the repayment period. Make sure to balance out your monthly payment with the total amount you will pay. Interest adds up quickly!
Choosing a career in this early stage of your life is a huge investment and it should not be taken lightly. Before you enter a profession and decide on the school of your choice, please do yourself a favor by evaluating your future income and the cost of your education. At the end of the day, education is an investment. Make sure that your investment works in your favor not against.

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Tae Kwan received his Doctor of Pharmacy degree from Temple University School of Pharmacy and expects to receive a Master of Business Administration f...