Understanding College Loans

Public v. private, student v. parent, here’s how to weigh your options.

The average college graduate leaves campus with $25,000 in student loans. When families exhaust their options—savings, scholarships and grants, many must turn to loans to pay the balance of the tuition bill. Navigating this course can be confusing and stressful. Read on to learn more about borrowing to pay for college (a list of additional resources appears at the end of this post).

Basic facts first The U.S. Department of Education offers college loans for both students and parents, classified as public loans. Banks, credit unions and lending services issue private student loans. For both types of loans, borrowers must reapply and qualify (via FAFSA for federal) each year for a loan for the next academic year.

Public loans This summer, federal student loans topped newsfeeds as Congress hashed out a long-term deal on interest rates. Federal student and parent loan interest rates are now tied to financial markets, which means they will vary from year to year. This year’s rate is 3.9% for undergraduates and 6.4% for PLUS (parent) loans. Called Direct Loans, these generally carry the lowest student loan interest rates.

1. Direct Subsidized Loans Colleges offer these federal loans to students based on need (i.e. info provided on FAFSA) as part of the financial aid package. The word subsidized means the government pays the interest on the loan while a student is in school at least half time and then for the first six months after they leave college. But the loans come with strict borrowing limits:

• Undergraduates, first year, $5,500, with $3,500 max subsidized.
• Second year, $6,500, with $4,500 max subsidized.
• Third year and beyond, $7,500, with $5,500 max subsidized.

The total amount a student can borrow through this program is $31,000.

2. Direct Unsubsidized Loans With these loans, the student is responsible for the interest on the loan from day one. Interest can be deferred until graduation, but it will accrue and be added to the principal. Borrowing limits are higher.

4. PLUS Loans Available to parents, these federal loans come with an annual fixed interest rate. The parent must have a good credit rating and can borrow no more than the cost of attending college after all other financial aid is applied. The government provides various types of repayment plans for these unsubsidized loans.

Private Loans If your student needs additional funds after they’re accepted their federal loan, they’ll need to look to banks, credit unions and other private lenders. The interest on these loans accrues from the start, with a choice between a fixed and variable rate. There can be tax deductions if payments are made while a student is in college.

• Explore student loan rates first. Expect that in order for your teen to receive the lowest available rate, you will need to cosign on the loan. (Read this article by Paul Oster of the New York Daily News on what to know before you cosign.) The fixed rates are almost guaranteed to be higher than those for a public loan.

• If you will be taking out a loan, consider whether you can access a home equity line instead, which might bring more favorable rates and repayment options, as well as a potential tax credit.

• Start with institutions where either you or your student is already a customer, which may entitle you to a slight rate reduction or faster loan processing. Most major banks issue student loans.

• Credit unions sometimes offer more competitive rates. Find out if you’re eligible to join one in your area.

• In addition, you may be receiving information in the mail from lenders like Discover Student Loans, who you may think of as a credit card company. The loans, and credit cards, are actually issued by Discover Bank.

Choosing a loan The most important step to take in borrowing for college is to access only as much money as you’ll need. Student borrowers should always start with federal loans, preferably subsidized, for the best rates and repayment options. Compare types of rates (variable v. fixed, plus any fees), repayment plans, qualifications, cosigner’s liability and borrowing limits.

If you find the information confusing, don’t be afraid to ask an experienced friend or relative or a financial aid officer at your student’s college for help. You want to do this right. College is an expensive investment.

Additional resources:

The Federal Student Aid site should answer many of your questions, especially under the “Types of Aid” tab.

LendKey provides information on loans offered by credit unions.

The Sallie Mae site, one of the largest issuers of student loans, provides answers to your questions about private loans.

Please share your experiences and advice for college student loans in the comments section below.