An insider's guide to student loans
Like every other aspect of lending,studentloanshave been dramatically affected by the credit crisis.
But don't believe rumors that you can't get loans for education anymore. They're still available -- and you still need to be careful about how much debt you take on.
Here's the scoop:
- Federal student loans are an even better deal than before. Rates are fixed now, rather than variable, and students with the most need will see rates as low as 3.4% in the future. Limits on how much you can borrow have been raised a bit, and parents who take out parental student loans now can defer payments while their kids are still in school. Although some lenders have exited the federal student loan market, the U.S. government has stepped in to make sure the remaining lenders had access to cash to make loans.
- "The government averted the crisis," said Mark Kantrowitz, the publisher ofFinAidand a co-author of "FastWeb College Gold: The Step-by-Step Guide to Paying for College." "You don't have to worry about getting (federal) student loans."
- Don't ask your lender for a consolidation loan. Consolidation allows you to make one payment instead of many, and you may be able to lower your payments by stretching out the repayment term from the usual 10 years to as many as 30. You still can consolidate your federal student loans, but you'll need to do so through the federal government. Lenders that used to make these loans have fled the market, saying they aren't profitable anymore. Visit the U.S. Department of Education'sloan consolidation siteto get started.
- Private student loans are harder to get. If you want to borrow more than the federal student loan limits (which range from $5,500 to $7,500 a year for college students, depending on their year and type of loan), you typically would turn to private student loans. These come with variable rates that currently average 11% to 12%. But lenders are demanding higher credit scores plus a co-signer these days.
"You used to be able to get a (private student) loan with a 620 FICO score," Kantrowitz said. "These days you need at least a 650 or even a 700."
Even if you qualify, you need to be extremely cautious about how much private student loan money you borrow. Here's why:
- Those variable rates are only going to shoot higher when the economy recovers and interest rates rise, Kantrowitz cautioned. Typically, private student loan rates aren't capped, so the sky's the limit.
- Private loans don't come with the forgiveness and income-based repayment options now available for federal loans.
- Private lenders will still loan you far more money than you can comfortably repay. They know you can't escape this debt, so they're comfortable piling it on. Student loan debt typically can't be erased in bankruptcy court, and there is no limit on how long private lenders can pursue you for collection.
So it's up to you to set limits on how much you'll borrow and search for the best possible deals.
How much should you borrow?
If you're a student,you should generally limit your debt so that yourloanpaymentsafter you graduate don't eat up more than 10% of your expected monthly income. Figure you'll pay $12 per month for every $1,000 of federal student loans you borrow if you repay the loan over 10 years. If you take on private student loan debt, figure you'll pay $16 per month for every $1,000, although you could well pay more.
If the math makes your head hurt, you can just use the rule of thumb that you shouldn't borrow more in total for your education than you expect to make your first year out of school. The rule doesn't work for all careers; lawyers, for example, may scrape away at a low-paying government job for a few years before departing for the big bucks in the private sector. But the rule should prevent most students from overdosing on debt.
If you're a parent,try to keep all your loan payments -- for mortgages, cars, credit cards and education -- to 35% or less of your gross monthly income. If you try to borrow more than 40% under some private loan programs, your application will be turned down.
Whether you're a parent or a student, though, you obviously should exhaust your federal loan options before applying for private loans.
Types of federal student loans
Federal loans come in three types:
- Subsidized loans, which are need-based.
- Unsubsidized loans, which don't require you to demonstrate need.
- PLUS loans, designed for parents and graduate students.
Subsidized loans include:
- Perkins loans.These are the best student loans of all and are awarded to students with "exceptional financial need" and come with a 5% fixed interest rate. You can borrow up to a maximum of $27,500 for undergraduate education and $60,000 for undergraduate and graduate school combined. Perkins loans can be canceled if you work in certain fields, such as nursing and law enforcement, volunteer for the Peace Corps or teach in a low-income area.
- Subsidized Stafford loans.Stafford loans are fixed at 5.6%, but the rates are scheduled to decline over the next three years until they hit 3.4% in 2011.
About two-thirds of subsidized Stafford loans go to families with adjusted gross incomes of $50,000 or less, Kantrowitz said.
If you don't qualify for a subsidizedStaffordloan, you may be offered the unsubsidized version. As with subsidized Staffords, the rate you pay will be fixed. Unlike the subsidized version, however, the government doesn't pay the interest for you while you're in college, so you could have sizable interest accrued by the time you graduate.
The limits on Stafford loans depend on several variables, including whether they are subsidized or unsubsidized, the degree sought and type of study. There's one other major type of federal student loan program: PLUS loans.
PLUS originally stood for Parent Loan for Undergraduate Students. But the program was expanded in 2006 to allow graduate and professional students to take out PLUS loans to fund their own educations. The loans typically allow the borrower to receive the difference between a financial-aid package and the full cost of his or her education, including books, supplies, room, board and other living expenses.
The maximum rate that can be charged for PLUS loans is 8.5%, although some lenders offer lower rates. Unlike the student loans discussed so far, however, you have to have decent credit to get these loans, and you'll need to start making payments shortly after the money is disbursed.
How do you get these loans?
To get Perkins or Stafford loans, you must first fill out aFree Application for Federal Student Aid, or FAFSA, before the start of each school year. You've got to jump through this hoop even if you don't expect to get any need-based aid or subsidized loans.
Perkins loans are made by the schools themselves. If a school participates in theFederal Direct Loan Program, then Stafford and PLUS loan applications also can be made through the school.
Otherwise, you'll need to apply to a bank, savings and loan or credit union that provides money under federal student loan programs. Your college's financial-aid office may recommend lenders, but you're free to choose your own.
To get PLUS loans, you don't have to fill out a FAFSA. Instead, the borrower submits a loan application and signs a promissory note. A credit check is required, and the application may be denied if the borrower has an "adverse credit history," which includes being 90 days or more late on a bill or being in default on a loan.
Forgiveness options
To help people drowning in student loan debt, Congress has expanded relief options.
For example, as of July, graduates have the option to limit payments on federal loans to no more than 15% of their discretionary income or 15% of the amount of their income that exceeds 150% of the federal poverty level. (For example, the 2009 poverty level for a single person is $10,830, so payments would be capped at 15% of his or her income over $16,245.)
Unpaid interest and principal are added to the loan, but any balance would be forgiven after 25 years of payments. (See "Can you get a student loan bailout?")
Congress also created aPublic Service Loan Forgivenessprogram in 2007. It wipes out student loan debt after 10 years of payments if the borrower works in a qualifying job, which includes:
- All government jobs -- federal, state or local.
- Military service.
- Police and fire departments.
- Public education and public health care.
- Social work.
- Public and school libraries.
- Public-interest legal services.
- Education in high-need areas.
- Nonprofit, tax-exempt 401(c)3 organizations.
For more details, read "Ask for student loan forgiveness" and "Solutions for borrowers who are having trouble repaying student loans."
What if you need more money?
If you've exhausted your federal loan options, you can look to private loans sponsored by not-for-profit organizations or provided directly by banks. Typically, the rates will be higher, the upfront fees greater, interest will begin accruing as soon as you get the money and your repayment options may not be as numerous. Also, your ability to get the loans and the rate you get usually depend on your credit history.
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