Choosing a Loan

For many families, it’s crunch time: your student has accepted admission at a college and now you have to figure out how to pay for it. Most families borrow some or all of the cost of college. There are tons of ways to borrow, and you can always find someone willing to loan you money for college. The key is to do it the right way.

Student loans fall into two big buckets: federal loans and private loans. Federal loans include Stafford and PLUS loans. Private loans are available from a myriad of lenders including Sallie Mae.

Federal loans are generally better than private loans for a variety of reasons: fixed interest rates, students can borrow without a co-signer, and they have various repayment options that make them less onerous: income-based payment plans, forbearance options, consolidation and more.

While there are some good lenders in the private loan space, there are also many who market through misinformation. Typical tactics include low teaser interest rates which then go up as high as 11% and quoting longer repayment terms in order to quote monthly payments lower than does a Stafford loan. Rarely is a private student loan a better deal than a federal loan if you do an apples-to-apples comparison.

The key points to consider when comparing loans are these:

  • Interest rate for the life of the loan. Keep in mind that interest rates are very low right now. It’s highly unlikely that the rate on an adjustable rate loan will go down over the term of the loan.
  • Repayment term and options to extend it. For example, the standard repayment term for a Stafford Loan is 10 years, but with consolidation and forbearance options, you may be able to extend it to 25 years. Remember that a shorter term will mean a higher monthly payment, whereas a longer term will mean that you pay more in interest over the life of the loan.
  • Monthly payment. Stafford Loans have a minimum $50 per month payment with standard repayment terms. When comparing monthly payments, it’s important to consider the term of the loan to determine if you’re really saving money when the quoted payment is lower. (Hint: the loan is cheaper if the interest rate is lower.)
  • Hardship options. Federal loans have income-based repayment options, and are discharged in the event of death or disability.
  • Loan fees. Stafford Loans have a 1.072% loan fee. PLUS loans have a 4.288% loan fee. Private loan fees vary by lender and loan.
  • Who is taking out the loan? Students and parents can borrow. There are pros and cons to each, regardless of who will actually be making the payments. I’ll discuss that in a future post.

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