Student Loans
College means debt. About two-thirds of all four-year undergraduate students will graduate college with debt, and the average amount of debt is more than $25,000. But by being smart about how you borrow, you can save thousands of dollars in interest over the lifetime of your loans.
First, you should prefer federal education loans over private student loans, as the federal loans have lower fees and interest rates. The major federal loan programs are:
- Perkins Loan. This is a low-interest loan available to students with exceptional financial need and available from the college. The interest rate is 5% and the government pays the interest while you are in school. Funding for this loan program is limited. Repayment begins 9 months after you graduate. There is a $5,500 annual loan limit for undergraduate students and a cumulative limit of $27,500. It has a 10 year repayment term.
- Stafford Loan. This is a low-interest loan available to all students. There are two versions. The government pays the interest on the Subsidized Stafford Loan while you are in school. The borrower is responsible for paying the interest on the Unsubsidized Stafford Loan while in school, but can capitalize it (add the unpaid interest to the loan balance). The interest rate on the unsubsidized Stafford loan is up to 6.8%. The interest rate on the subsidized Stafford loan for undergraduate students is 5.6% in 2009-10 and will be dropping to 4.5% in 2010-11 and 3.4% in 2011-12. Both loans have fees of up to 1.5%. The subsidized Stafford is based on financial need, while the unsubsidized Stafford is not. Any amounts not received as a subsidized Stafford can be borrowed as an unsubsidized Stafford. Repayment begins 6 months after you graduate. College freshmen can borrow $5,500 (no more than $3,500 subsidized), sophomore students can borrow $6,500 (no more than $4,500 subsidized), and juniors and seniors (and beyond) can borrow $7,500 (no more than $5,500 subsidized) per year. There is also an aggregate loan limit of $31,000 (no more than $23,000 subsidized). Graduate students can borrow more, up to $20,500 per year. It has a 10 year repayment term.
- PLUS Loan. This is a low-interest loan available to graduate and professional students and the parents of undergraduate students. Repayment begins 60 days after disbursement, but one can defer payments and capitalize the interest while the student is in school. The maximum interest rate is 8.5%. There is no cumulative loan limit, and the annual loan limit is the cost of attendance minus any other aid received. This loan does require a modest credit check that three-quarters of prospective borrowers will pass. If the undergraduate student’s parents do not qualify for the PLUS loan, or the student is an independent student, the student will qualify for additional unsubsidized Stafford loan limits ($4,000 per year for freshmen and sophomores, and $5,000 per year for juniors, seniors and beyond). It has a 10 year repayment term.
- Consolidation Loan. After you graduate, you will have four loans, one for each year in school. A consolidation loan, which is like a refinance, lets you combine these loans into a single loan. It also lets you reduce the size of your monthly payment by increasing the length of the loan up to 30 years, based on the amount borrowed. (Increasing the loan term will also substantially increase the interest you pay. Going from a 10 year loan to a 20 year term will cut the monthly payment by about a third, but at a cost of more than doubling the total interest paid.) The interest rate on a consolidation loan is the weighted average of the rates on the loans being consolidated, rounded up to the nearest 1/8th of a point, and capped at 8.25%.
Private student loans are not government-guaranteed. The interest rates and fees are set by the lender. Interest rates are variable rates that are pegged to your credit score. Borrowers with bad credit will need a creditworthy cosigner to qualify. Even borrowers with good credit should apply with a cosigner, as this will often result in a lower interest rate and lower fees.
While the federal government sets the maximum rates and fees on the Stafford and PLUS loans, nothing prevents a lender from charging lower rates. So it can pay to shop around. Many lenders offer discounts that can save you hundreds or thousands of dollars of interest over the lifetime of your loans. But beware of prompt payment discounts which require you to make all your payments on time. Most borrowers find it difficult to qualify for such discounts, with less than a quarter of students making the first 36 payments on time. Instead, focus on discounts that are immediate and which you can’t lose. For example, many lenders offer discounts if you sign up to have your monthly payments automatically debited from your bank account. Others may rebate or waive the loan fees. A few will even reduce the interest rate without requiring you to jump through hoops. The discounts on consolidation loans tend to be inferior to those on unconsolidated Stafford and PLUS loans, since lender margins are tighter on consolidation loans.
The college preferred lender list is often a good starting point. But also consider other lenders, and compare costs, instead of simply picking the first lender on the list. You are not required to use a lender recommended by the school.
Borrow as little money as you can. Live like a student while you are in school, so you don’t have to live like a student after you graduate. A good rule of thumb is that your total education debt should be less than your expected starting salary. If you borrow more than that, you’ll find it difficult to repay the debt. Also be careful with other forms of debt, such as credit cards.
For more information about student loans, see www.finaid.org/loans.
Reprinted with the permission of FinAid. © 2008 by FinAid Page, LLC. All rights reserved.
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