12.22.2022 Jodi Anderson
If you are in need of a loan for college, it is important that you understand how to compare your options in order to get the best deal for your family.
Students typically should borrow Federal Direct Subsidized and/or Unsubsidized Loans before seeking a loan elsewhere. These loans have low fixed rates and the most flexible repayment options on the market. If your family applied for financial aid, these loans would have been included in the student's financial aid award letter.
However, federal student loan options have annual borrowing limits and unfortunately, for many families, the amounts aren't enough to cover the total amount they need to pay to the college. That is where other options come in and when comparing becomes necessary.
The remaining loan types fall into three major categories: federal, state-based, and private.
Additional Federal Loan Options
The Federal PLUS Loan is for parents of undergraduate students. Graduate students in need of additional funds may also borrow a Federal PLUS Loan. The PLUS Loan has a fixed rate, which is reset every May, and an origination fee, currently over 4%. The rate on the Federal PLUS Loan is higher than the rate on the federal student loan options. For example, for the 2019/20 academic year, the Federal PLUS Loan rate is set at 5.30%, compared to 2.75% for the Direct Subsidized and Unsubsidized loans for undergrads.
State-based Education Loans
State-based loans are a type of private loan offered through a network of non-profit lenders. State-based loans often offer rates lower than the Federal PLUS Loan and may be in the student's or parent's name, depending on the program. If the loan is in the student's name, a cosigner will likely be needed, but some programs have cosigner release options. Rates and fees vary from program to program. You can review RISLA's programs at: risla.com/student-loans.
Private Student Loans
The last loan type is private education loans. These loans are offered through for-profit banks and other lending organizations. Most have both fixed rates and variable rate loans, with discounts for existing customers. Rates are often based on your credit score, the term of the loan and your degree level. so don't be fooled into thinking that the lowest advertised rate is what you will receive, unless you have excellent credit and are pursing an advanced degree with the shortest term.
Factors to compare on student loans
Here is a list of things you should be looking at when comparing the above loan types to ensure you get the best option for your personal circumstances.
Interest Rate
What is the interest rate on the loan? Is the rate fixed or variable? A lower rate is better, but be careful to pay attention to other factors too. For example, a low rate on a variable rate loan may not be low in a few years when you enter repayment. Assess your family's appetite for risk before taking on a variable rate loan, and make sure you understand how the index that rates are based on can change over time. Be particularly careful with any variable rate loan based on the LIBOR index, as that index will be expiring in the near future!
Annual Percentage Rate (APR)
The Annual Percentage Rate is a rate that expresses the total cost of a loan, including the interest rate, and any additional fees or other finance charges. You can use the APR to get a better cost comparison of private loans than looking at the interest rate alone. But be careful, as Federal student loans are exempt from APR disclosures. For federal loans, be aware that fees are paid up front and are extracted from the loan proceeds sent to the school.
Fees
Make sure you understand what fees are involved with any loan. Are there any upfront fees? Upfront fees are fees required by a lender in order to get the loan. Lenders often refer to these as application fees, origination fees, processing fees, documentation fees, or something similar. Similarly, be aware what the back-end fees are. Back-end fees are those fees that are completely avoidable if you manage your repayment. Fees for returned payments, late payments, and defaulting are back end fees. While you don't want to plan on being delinquent on your loan, it is good to know how it will affect you should unfortunate circumstances prevent you from making payments as agreed.
Deferment & Forbearance Options
These options are ways of delaying your student loan payments. First, you want to know if the loan will be deferred while the student is in school. If so, is there a maximum amount of time the loan can be deferred? Keep in mind, deferring payments while in school increases the total amount you pay over the life of your loan so if you can make payments now, do it! Next, ask about whether the loan can be deferred again if the student re-enters school after graduation or takes a break. Lastly, find out what the forbearance options are and how much time you can get if you can't make payments due to your financial circumstances.
Repayment Term
How long will you have to repay your loan? A shorter term typically results in less finances charges, but a higher monthly payment. A longer repayment term will cost you more in the long run but may make your monthly payments more manageable.
Monthly Payments
Ask the lender to estimate what your payments will be based on the amount you are considering borrowing. Take into account all four years of borrowing (or more) when determining if the monthly payment amount will be affordable. Also take into account the rate type. The estimate for a variable rate loan is just that, an estimate, and as the index rate changes, so will your monthly payment.
Payment Flexibility
Unlike car loans, mortgages, and credit cards, student loans usually offer a bit of repayment flexibility. Deferment and forbearance are examples of this flexibility. However, not all programs offer the vast array of options as the Federal Direct Subsidized and Unsubsidized Loans, which comes as a surprise to many students after school. Life is unpredictable for new grads, so make sure you understand what options are available after graduation, such as graduated, extended or income-based repayment plans, if any. Make sure you have a contingency plan (such as your cosigner making payments) if you are unable to afford your payments at any time so you don't damage your (and your cosigner's) credit which can take years to recover from.
Cosigners
Most non-federal loans will require a cosigner. If a cosigner is not required, the interest rate is typically higher. If you are the cosigner on a student loan, make sure you understand your obligation and read the fine print before you sign the Promissory Note. Cosigners are often surprised when they start getting calls from lenders looking for payments. But if the student doesn't pay, you are on the hook for the loan. Take this seriously and make sure you can afford the payments on the loan if the student cannot.
Use this list to compare your options and then make a chart of pros and cons before deciding which is right for you. Need more information on college financing? Book an appointment with RISLA's College Planning Center and Download RISLA's Guide to College Borrowing.
