I recently received this email from a reader:
I need some Buyer Beware advice on how to choose a lender for a student loan with a parent as co-signer. My 19 year old will be attending university and he has to take out 100% loans. The annual amount is a hefty 50K. When I review the lenders listed on the university’s recommended lender list, I do not have enough knowledge to know how to choose a lender. The interest rate is always variable on any student loan when it is in the student’s name and the parent a co-signer. But there is a lot of fine print attending each loan that I simply do not understand. Given what has happened with the sub-prime mortgages I feel that I might be stepping into a black hole with the student loans. The two categories of sub-prime mortgages and student loans appear to be very similar.
Obviously, it’s going to be impossible to describe every type of student loan in a single post, so instead I will offer some basic tips for evaluating student loan options. I went through this process myself not all that long ago and the scars are still fresh in my mind.
General Student Loan Categories
In the United States, student loans generally fall into these general categories:
Federal student loans to students
This group of loans include Perkins loans, Stafford loans, Federal Family Education Loans (FFELs), and Ford Direct loans. These loans are guaranteed by the federal government and are generally a very good deal. There are subsidized and unsubsidized versions (subsidized is better, as they’re basically interest-free while the student is in school) – the subsidized one has some pretty strict income requirements. The drawback is that they have a very low cap: $3,500 for incoming freshmen in 2007. In the past, rates on these loans have been very nice, but they are set to start approximating the rates on private loans starting later this year.
Federal student loans to parents
PLUS loans are federal government loans directly to parents for the purpose of paying for college. These are not loans that the student will repay – the parent is solely on the hook for them. Again, the rate used to be quite nice, but the rates are going up later this year.
This is the meat and potatoes of it, the type of loan that most people will wind up having to take because other sources didn’t cover the cost of education. These are basically consumer loans from private lenders with no collateral, which often means that the rates are not particularly comfortable.
Six Tips For Comparing Student Loans
It is very difficult to offer concrete advice on which loan offers to take without looking at the options, but here are six tips that can help you separate the good from the bad.
Use the APR to compare the loans, not the “rate” The “rate” that many loans give out is not really very useful for comparison, because many loans with low rates have a ton of additional fees tacked on. The real tool for comparing the loans is the stated APR, which includes the various fees that they tack on. Remember, though, that APR isn’t perfect – it’s only an exact comparison tool for loans that have the same term. This, of course, means that you should…
Shop around thoroughly, regardless of the stated “rate” Many companies thus use a very low “rate” in order to attract your attention, then effectively do a bait and switch, giving you a loan with a very high APR and a low “rate” because of all the other stuff tacked on in the middle there. Thus, don’t toss out loan offers because they have a high rate – they may have low fees in other respects.
If you have difficulty with the APR and term math, ask what the monthly payment will be and multiply it out by the term For example, if you’re trying to compare a ten year and a twenty year loan, find out what the monthly payment will be for each and then multiply that payment by twelve, then by the number of years you’ll have the loan to see how much you’ll be paying total. Obviously, you want the smaller amount here.
Look at fixed-rate loans unless you think the Fed is going to significantly start dropping rates I’m not the right person to be giving long-term advice on where interest rates are headed. My suggestion is to talk to people in the finance industry (especially those you trust) and ask them whether they think the prime lending rate will be on average lower or higher over the next ten years. If they think higher or about the same, get a fixed-rate loan, otherwise get a variable-rate loan. I was luckily able to lock in some fixed rates in 2003 when loan rates were very, very cheap – I actually do better with my money in an HSBC Direct savings account than paying off my loans early.
High origination fees are usually a red flag If an origination fee for one loan is excessively high compared to the others, this may be a red flag, especially on a variable-rate loan, because the rate could skyrocket and the origination fee (tacked onto the overall balance) will really hurt you in the long run. Small differences aren’t usually that big of a deal, but if you’re looking at double or triple difference in origination fees, something’s afoot.
Check your credit report If the borrower or the cosigner have poor credit, the terms for the loan will likely be worse. Thus, one part of the process is to check the credit report of everyone who might be signing for the loan and then ensure that the people with the best credit do the signing.