The Basics for Loans

Few students can afford to pay for college without some financial assistance. The typical undergraduate completes college with $16,500 in student loans. Graduate and professional students borrow even more. Grants, scholarships, work-study programs, and other forms of gift aid can greatly supplement a student's savingsbut should never be counted on as the only way to cover the full cost of a college education. Many students find they must supplement their savings with government and private loans. Federal education loan programs offer lower interest rates and more flexible repayment plans than most consumer loans, making them an attractive way to finance education.

A loan is a form of financial aid that must be repaid, with interest. (Scholarships, on the other hand, do not have to be repaid.)

Student Loans (Also Called Stafford and Perkins Loans)

The federal loan for students is called the Stafford Loan and has two variations.

1. If the Stafford Loan is administered by the Federal Family Education Loan Program (FFELP), the funds are provided by private lenders, such as banks, credit unions, and savings and loan associations. These loans are guaranteed against default by the federal government.
2. If the school you want to attend is a "Direct Lending School," your Stafford Loan is administered by the Federal Direct Student Loan Program. Funds for "direct loans" are provided by the U.S. government directly to students and their parents through their schools.

Stafford Loansallow dependent undergraduates to borrow up to $2,625 their freshman year, $3,500 their sophomore year, and $5,500 for each remaining year (independent students can borrow an additional unsubsidized $4,000 the first two years and $5,000 the remaining years). Graduate students can borrow $18,500 per year, although only $8,500 of that is subsidized. Many students combine subsidized loans with unsubsidized loans to borrow the maximum amount permitted each year.

Stafford Loans have variable interest rates (based on 91-day T-bill rate plus 1.7 percent during school, with an additional 0.6 percent increase upon graduation) capped at 8.25 percent or less, depending on yearly adjustments. All lenders offer the same rate for the Stafford Loan, although some give discounts for on-time and electronic payment.

To apply for a Stafford Loan, you must submit the Free Application for Federal Student Aid (FAFSA). Even though the unsubsidized Stafford Loan is available to all students regardless of financial need, you must still submit the FAFSA to be eligible. You can receive a subsidized loan and an unsubsidized loan for the same period.

The Perkins Loan is awarded to undergraduate and graduate students with exceptional financial need. This is a campus-based loan program, with the school acting as the lender using a limited pool of funds provided by the federal government. The Perkins Loan is the best student loan available. It is a subsidized loan, with the interest being paid by the federal government during the in-school and nine-month grace periods. There are no origination or guarantee fees, and the interest rate is 5 percent. There is a 10-year repayment period.

The amount of Perkins Loan you receive will be determined by the financial aid office. The program limits are $3,000 per year for undergraduate students and $5,000 per year for graduate students, with cumulative limits of $15,000 for undergraduate loans and $30,000 for undergraduate and graduate loans combined.

Institutions participating in the Expanded Lending Option (ELO) may offer higher loan limits for the Perkins Loan. To participate in the ELO, a school must have a default rate no higher than 15 percent. The annual loan limits are increased by $1,000 each and the cumulative limits increased by $5,000 and $10,000, respectively. The Perkins Loan also offers better cancellation provisions than Stafford Loans or Parent Loans for Undergraduate Students.

Parent Loans for Undergraduate Students (Also Called PLUS Loans)

PLUS loans have variable interest rates (based on 52-week T-bill rate plus 3.10 percent) capped at 9 percent. Repayment begins 60 days after the funds are fully disbursed, and the repayment term is up to 10 years. Some lenders offer a slight discount for automatic payment plans.

PLUS loans are the financial responsibility of the parents, not the student. If the student agrees to make payments on the PLUS loan but fails to make the payments on time, the parents will be held responsible.

Private Loans (Also Called Alternative Loans)

Private loans, also known as alternative loans, help bridge the gap between the actual cost of your education and the limited amount the government allows you to borrow in its programs. Private loans are offered by private lenders, and there are no federal forms to complete.

Some families turn to private loans when the federal loans do not provide enough money or when they need different repayment options. For example, a parent might want to defer repayment until the student graduates, an option that is not available from the government parent loan program.

Lenders provide different types of private loans, depending on the student's level of study.

Loan Consolidation

Consolidation loans often reduce the size of the monthly payment by extending the term of the loan beyond the 10-year repayment plan that is standard with federal loans. Depending on the loan amount, the term of the loan can be extended from 12 to 30 years. The reduced monthly payment may make the loan easier to repay for some borrowers. However, if the term of a loan is extended, the total amount of interest paid is increased.

In certain circumstances (for example, when one or more of the loans was being repaid in less than 10 years because of minimum payment requirements), a consolidation loan may decrease the monthly payment without extending the overall loan term beyond 10 years. In effect, the shorter term loan is being extended to 10 years. The total amount of interest paid will increase unless you continue to pay the same monthly payment as before, in which case the total amount of interest paid will decrease.

The interest rate on consolidation loans is the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of a percent and capped at 8.25 percent. Some graduate students have found it necessary to consolidate their educational loans when applying for a mortgage on a house.

Consolidation simplifies the repayment process but does involve a slight increase in the interest rate. Students who are having trouble making their payments should consider some of the alternate repayment terms provided for federal loans. Income-contingent payments, for example, are adjusted to compensate for a lower monthly income. Graduated repayment provides lower payments during the first two years after graduation. Extended repayment allows the term of the loan to be extended without consolidation. Although each of these options increases the total amount of interest paid, the increase is less than that caused by consolidation.