Student Loans
Overview
A college education may be the most important investment in a child's life and has become one of the most costly, too. The publicly reported tuition charged by private colleges and universities for can reach $50,000 or more a year. The trends are alarming, too. And while tuition at public universities is generally lower, costs there have been growing even more steeply in recent years as government support has lagged.
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But understanding how student loans work is not easy, and the unwary borrower can end up paying a high interest rate for years after graduation. For the millions of students who will need to borrow to pay for college, it makes sense to learn about the financial aid system even before applying.
The landscape for loans is about to change. Included in the legislation that completed the health care reform package were provisions to force commercial banks out of the federal student loan market, cutting off billions of dollars in profits in a sweeping restructuring of financial-aid programs and redirecting most of the money to new education initiatives.
Since the bank-based loan program began in 1965, commercial banks like Sallie Mae and Nelnet have received guaranteed federal subsidies to lend money to students, with the government assuming nearly all the risk. Democrats have long denounced the program, saying it fattened the bottom line for banks at the expense of students and taxpayers. The legislation, proposed by President Obama in 2009 and fiercely opposed by banks, substitutes an expanded direct-lending program by the government for the bank-based program, directing $36 billion over 10 years to Pell grants, for students from low-income families.
Types of Loans
Doing away with federally guaranteed private loans whittled the three basic types of loans undergraduate students should know about down to two: federal loans made by the government directly, and private or alternative loans from banks or other private lenders that carry no federal government guarantee. (Sometimes a college itself may make loans, too, usually in partnership with a financial institution.)Every student should first look to federal loans because the interest on these loans is capped at a fixed rate set by Congress. Every financial aid administrator at every college in the country should tell students this. And students should be wary of any lender that tries to steer them away from federal student loans.
Federal loans remain the gold standard for borrowers. Unlike private loans, they allow more latitude when it comes to repayment, something that is relevant to these economically troubled times. Repayment based on income can offer relief; it can be calculated using the percentage of discretionary income, not the amount owed.
The most popular federal loans are the Stafford loans, available to students regardless of financial need.
There are two types of Stafford loans available to students. For those who demonstrate sufficient financial need, the government will pay the interest on "subsidized" Stafford loans for students while they are enrolled in college. Otherwise, loans accumulate interest while a student is in school, and the student may either pay that interest as it comes due or let it be added to the principal balance.
Perkins loans are available to students who have the greatest financial need; priority is given to students receiving federal Pell grants, which are awarded to low-income students. Parents of students can also take out federal loans, known as Parent PLUS loans (Parental Loans for Undergraduate Students).
Families taking out PLUS loans can borrow enough to cover their full "cost of attendance" less any other financial aid, like scholarships or grants, that they receive. The cost of attendance is defined by law and is made up of more than just tuition and fees, and includes room and board, an allowance for books and supplies, transportation and other personal expenses. Every college should provide incoming students with its cost of attendance.
The federal Education Department has information on Stafford, Perkins and PLUS loans on its Web site, which can be hard to navigate.
The simplest way to borrow may be directly from the federal government, through the William D. Ford Federal Direct Loan Program. But this option exists only for students attending a college that participates in the direct loan program. For students attending institutions that do not participate, shopping around is a good idea.
Interest on Federal Loans
Congress sets the interest that a lender can charge on federal loans, and most lenders do charge the maximum. Currently the maximum interest rate on new Perkins loans is 5 percent. On unsubsidized Stafford loans, the rate is 6.8 percent. For subsidized Stafford loans, the rate is 5.6 percent — the government pays the interest (dropping to 4.5 percent for 2010-11 and 3.4 percent for 2011-12). The lower rate is only for undergraduate students; graduate and professional students still pay 6.8 percent on both types of Stafford loans. On PLUS loans, borrowers pay 7.9 percent if they borrow through the direct loan program. Students should check these rates because they do change. The Education Department currently posts the maximum rates.The government also imposes limits on how much money students may borrow under each type of loan program. As of July 1, 2008, the typical dependent Stafford borrower can take out $5,500 in the first year of college, $6,500 the second year and $7,500 in later years. The maximum amount an undergraduate can borrow through the Stafford loan program is $31,000. These loan limits are specified here.
Filing the FAFSA
Where to begin? The first step is not so easy -- filling out the Free Application for Federal Student Aid, or FAFSA. But Congress moved to simplify this form as part of the Higher Education Opportunity Act of 2008. More good news: it is still free and can be completed online. The reward for slogging through it is eligibility for the federal loans and grants, which may save a borrower hundreds or thousands of dollars in interest.Any borrower's first choice, of course, would be the Perkins loans, for those who qualify. Then look to see if your school participates in the direct federal loan program.
For more detailed tips on shopping for a Stafford loan, check out this article.
Private Loans: The Wild West
For those students who need to borrow more money than is available through a federal loan program, there are "private" or "alternative" loans. These are basically just like any other consumer loan from a bank or student loan company. The interest rates charged on private loans are almost always higher than those on federal loans, and the interest rates can change over time.The interest rates on these loans also vary from lender to lender and from borrower to borrower, leading some to describe the private loan market as the "wild west" of the student loan industry. Because there is so much variability in loan terms, students must apply for a loan merely to find out what rate they might have to pay. This can be time consuming, but it is better to shop around than to accept a rate that is going to make repayment difficult. The rates charged can vary dramatically.
Because private loan interest rates change over time, it is more difficult for borrowers to predict their monthly payments in the future. In general, students should borrow as little as they can in the form of private loans, no matter how much easier the application process is than the FAFSA.
Private loans also do not enjoy some of the protections that federal loans provide, such as the possibility of temporary deferment or forbearance –- meaning that a borrower does not have to make payments on a loan under certain circumstances. There is more information about how to cope with repayment difficulties for federal loan borrowers.
Getting Advice
In the wake of all the negative attention to financial aid offices in 2007, students might well be nervous about relying on advice they get from their colleges or about borrowing from a company on a college's list of "preferred" or "recommended" lenders.While it is certainly the case that in 2007 investigators for Congress and various state attorneys general uncovered questionable relationships between lenders and both colleges and individual financial aid administrators, students should still start with their financial aid offices. More coverage of the tangled arrangements some colleges had with lenders is available here, here and here. Many of these arrangements have since ended.
But students should learn from the financial aid scandals and should ask, for example, how recommended lenders were selected and what are the terms of the loans those lenders offer? Under the terms of an agreement with the New York attorney general's office, more and more lenders are required to tell colleges exactly how much students are paying in interest.
For more information, there are plenty of Web sites out there aimed at future college students. Some sites even can help compare loan terms from different lenders to help students choose the best deal, like SimpleTuition and Graduate Leverage. For a comparison of the sites, you can check Finaid's Web page. But some sites are in fact owned by lenders or other companies, or – like SimpleTuition - they are paid referral fees by lenders, so students should not rely on any one source of information.
Some helpful sites are maintained by both nonprofits and for-profit organizations not directly in the student loan business. Those seeking to learn more may want to check out The Institute for College Access and Success (www.ticas.org). The nonprofit's Project on Student Debt provides tips on shopping for and comparing different student loans.
Most of the information provided discussed above is included in the Education Department's Guide to Federal Student Aid [PDF].
After reading this far, you might feel like as much work is involved in paying for school as getting through it. But remember: a little effort now could pay off in savings for years and years after graduation.
