Best Deals on Student Loans
The feds will lend you all the money you need for an Ivy League education.
By Jane Bennett Clark, Senior Associate Editor
From Kiplinger's Personal Finance magazine, July 2007
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The majority of schools, however, leave it to you to choose a lender, and that's where the process gets tricky. Commercial lenders vie for your business by offering to waive processing fees, pare the fixed rate and bestow rebates on borrowers who pay electronically or on time for, say, 24 or 36 consecutive months. Comparing those sweeteners can drive you crazy, says Thom Hunzicker, a college financial planner in San Dimas, Cal. "It's hard to research this stuff. There should be a way to quantify the moving parts."
Over the years, financial-aid offices have tried to do just that by vetting deals and sending families a list of preferred lenders. Recently, some financial-aid officers have been accused of accepting their own sweeteners, such as stock options and trips, from lenders who appeared on the lists. Other institutions have acknowledged taking money from lenders in exchange for sending borrowers their way.
Such back-scratching may have blemished the integrity of the lists, but you should still start there, says Keith Landis, of Collegiate Advisors, which provides technical backup to college financial planners. Colleges have more clout than the average 18-year-old. "In most cases, the price the student gets through the preferred-lender list is still better than what the student would get directly from the lender," says Landis.
Cover your bases by checking a few other programs (you can find a list of lenders and their discounts at www.finaid.org). Investigate nonprofit lending agencies in both your state and the state where your child will attend school. Such agencies use low-cost loans to encourage students to study -- and stay -- within state borders. For instance, the College Foundation of North Carolina offers a dirt-cheap 4.3% interest rate on Staffords (after discounts) to state residents, out-of-state students attending college in North Carolina and families who contribute to the state's 529 savings plan.
Wherever you shop, look for up-front benefits, such as an interest-rate reduction at the start of repayment, rather than future perks -- say, for making 36 on-time payments. "That's like saying, if I make the 260th through the 290th payment on my mortgage on time, I'll get a discount. No one ever does that," says Landis. Keep in mind, too, that many students consolidate their loans early in repayment, rendering future discounts meaningless.
Dip into home equity
If you're a homeowner, you've probably already considered using home equity to cover some of the college bills. Borrowing against home equity makes sense if you earn too much to qualify for the student-loan interest deduction. You can deduct interest on up to $100,000 of home-equity loans.
Some college financial planners recommend going with a home-equity line of credit, which lets you borrow money as you need it, rather than taking a second mortgage and paying interest on the whole amount. But the line of credit's variable rate, currently at almost 9%, puts you at risk, says Hunzicker. "Who knows what will happen with interest rates?" He prefers second mortgages with fixed rates, lately about 8.2%.
One more consideration: A home- equity line of credit can enhance your chances for financial aid, whereas a second mortgage can hurt them, depending on whether the school counts home equity as an asset. Before you jump into one or the other, find out how the school determines financial need.
Protect retirement
You deserve a scolding for even thinking of borrowing against your 401(k) retirement account. "All you're doing is postponing the problem," says Carpenter. "You may be signing on for another five years of work because you don't have enough money to retire."
You're required to pay back a 401(k) loan within five years. But if you leave your job, you must repay it immediately or owe taxes on the amount, plus a 10% penalty.
In a pinch, go private
Given all the other choices, you'd think students could avoid resorting to private loans. Not so. Private loans have become the fastest-growing sector of the student-loan industry, totaling $16 billion in 2005-06. Undergraduates who use private loans borrow an average of $6,000 a year, and graduate students dig themselves in to the tune of more than $8,000.
Private-loan interest rates, which are variable, depend on the prime rate or LIBOR benchmark as well as the borrower's credit rating. The best deals, according to FinAid, carry an interest rate of LIBOR plus 1.8%, or prime minus 1%, with no fees. But only about 20% of borrowers get the lowest rates, says Kevin Walker, of SimpleTuition (www.simpletuition.com), which compares private loans. Borrowers with poor credit can expect to pay up to six percentage points more than the advertised rate, according to FinAid, and fees that are significantly higher.
You can't know the rate you'll be charged without actually applying. Shireman, of the Project on Student Debt, recently tested the market by applying for several private loans, using comparison sites such as SimpleTuition. Despite a top credit score, he ended up with offers ranging from 7.9% with no fees to almost 10% plus 4% in fees. No offer matched the teaser rate.
Bottom line? Max out the federal options, then shop for private loans that track federal loans as closely as possible, including those that let you defer or extend repayment, says Draeger. State agencies, such as the College Foundation of North Carolina, offer private as well as federal loans. Check them out first.