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Loan Basics

How you borrow is just as important as how much you borrow. Different borrowing programs have different interest rates, repayment plans, and loan limits, and the choices you make now will affect you for the next ten years—the average time it takes to repay a student loan. In order to choose the loan program that’s right for you, you need to understand ten basic things about loans:

Need-based loans

Loans based on need, such as the Perkins loan or the subsidized Stafford loan, are usually the best borrowing options, with low interest rates and generous repayment options. Some financial aid offices may choose to use these student loans instead of institutional scholarships or grants in order to meet your overall need.

Non–need-based loans

Loans not based on need generally have higher interest rates and stricter repayment options than need-based loans.

Subsidized loans

Subsidized means that while you are enrolled in school at least half-time, the federal government will pay any interest that accrues on your loans.

Unsubsidized loans

With unsubsidized loans, you are responsible for any accrued interest as soon as the loan is issued.

Deferment

Deferment allows you to postpone loan repayment as long as you are enrolled in school at least half-time. Deferment applies mainly to federal student loans. During deferment of subsidized Stafford Loans and Perkins Loans, the federal government will pay any interest that accrues. You are responsible for repaying the interest on any unsubsidized loans during deferment.

Forbearance

A lender will grant you forbearance when you are unable to make your loan payments because of financial hardship, unusual circumstances, or participation in a national service program such as AmeriCorps. Forbearance is a temporary reprieve, not a permanent solution, and the federal government does not pay the interest the loan accrues during this time. You’ll have to pay up eventually.

Grace period

A loan’s grace period is the period of time before you have to begin repaying your loan. A grace period usually begins as soon as you graduate from college or drop below half-time enrollment. Stafford Loans have a six-month grace period, while Perkins Loans offer a grace period of nine months.

Origination fees

You pay origination fees in order to receive a loan. Origination fees are used to cover the administrative costs of student loans and vary greatly depending on the type of loan. Perkins Loans have no origination fees, while private student loans have origination fees that can exceed 10 percent.

Guarantee fees

Guarantee fees are essentially insurance coverage for students who don’t pay back their loans. These fees can vary greatly from loan to loan, but they are lowest with the federal student loans and highest among the nonguaranteed private student loans.

Default

If you fail to pay your student loan, you are in default. Defaulting on a student loan will prevent you from receiving any future financial aid until you pay up. There’s no easy way out: You can’t get rid of a defaulted student loan by declaring bankruptcy. Defaulting on a loan can negatively affect your credit rating and can lead to garnishment of your wages and/or withholdings from any federal income tax refunds. In other words, you won’t get your paycheck or tax refund—your lender will. And finally, one more reason not to go into default (as if you needed one more): You can’t get either deferment or forbearance on a defaulted loan.

The Perkins Loan

Established in 1958 under the National Defense Student Loan Program, the federal Perkins Loan is one of the oldest forms of financial aid—and one of the best loans available.

The government funds the Perkins Loan, but colleges administer it, which means the college is the lender. When you begin repayment, you’ll send your money back to the college. If you have any questions about your loan, you’ll need to talk directly with your school. Some students see this as a benefit.

Not every college participates in the Perkins Loan program, and even colleges that do participate usually have a very limited amount of money to distribute. If you want a Perkins Loan, you should complete the FAFSA and institutional financial aid applications as soon as possible.

The Perkins Loan is as good as it gets when it comes to borrowing. The interest rate is set at 5 percent; repayment does not begin until nine months after you graduate or drop below half-time status; and there are no origination or guarantee fees. Students can typically borrow up to $20,000 for undergraduate studies, $4,000 per year. The Perkins Loan can also be forgiven or discharged in a number of ways.

While many students view the Perkins Loan as the best loan, you should be aware of the drawbacks. First, recently the interest rates of subsidized Stafford Loans have been lower than the 5 percent fixed rate of the Perkins Loan. This means for now, subsidized Stafford Loans are actually the better option. Although the low interest rates on the Stafford Loans will probably not last, it is still a good idea to research current Stafford Loan rates before blindly accepting the Perkins Loan.

The Stafford Loan

The Stafford Loan is now the largest single financial aid pro-gram in existence. When students or financial aid administrators talk about student loans, they are almost always referring to the Stafford program.

In order to take a Stafford Loan, you must complete the FAFSA. Stafford Loans are far more abundant than the Perkins Loan or Supplemental Educational Opportunity Grant, so completing your FAFSA late will probably not affect your Stafford eligibility.

There are two kinds of Stafford Loans: subsidized and unsubsidized. The main difference between the two is who pays the interest and when. The federal government will pay any interest on subsidized Stafford Loans while you are enrolled in college at least half-time. Since students typically take five or more years to graduate, this benefit can be substantial. Subsidized Stafford Loans are given based on need.

The government does not pay the interest on your unsubsidized Stafford Loan at any time, which makes it a less favorable form of aid than the subsidized Stafford. As soon as you get the loan, interest will begin to accrue. However, you can choose to defer payment of this interest in a process known as capitalization. This means that the interest is added to the principal of the loan upon graduation, and you can pay it all off together. You can qualify for the unsubsidized Stafford Loan regardless of need.

The interest rate of the Stafford Loan is capped at 8.25 percent. However, it can fall substantially below that rate since it’s a variable rate loan (which means it follows the rate set by the Federal Reserve). In fact, the interest rate on a Stafford Loan hit an all-time low of 3.37 percent in July 2004. It’s also important to understand that the interest rate on a Stafford Loan is actually 0.6 percent lower while you are in school and during your grace period.

Fees

Stafford Loans, unlike Perkins Loans, come with origination and guarantee fees. These fees cover the administrative costs needed to run the Stafford program, as well as provide insurance against those students who default on their loans. The fees are usually up to 1 percent for guarantee and up to 3 percent for origination. However, many lenders are now offering more competitive guarantee and/or origination fees. If you are borrowing a Stafford Loan at a school that allows you to use private lenders, make sure that you shop around for the best deals.

The Department of Education allows anyone with a Perkins or Stafford Loan to check their loan amount online at the National Student Loan Data System. Visit www.nslds.ed.gov to sign up.

There are many free online programs that can help you calculate what your monthly loan payments will be depending on how much you borrow. One of the best is www.finaid.com.

The PLUS Loan

The Parent Loan for Undergraduate Students (PLUS) is an unsubsidized loan parents borrow on behalf of their dependent children enrolled in college as undergraduates. The PLUS loan may be used to pay any costs not covered by your other financial aid, all the way up to your total COA. Interest rates for the PLUS loan are capped at 9 percent, and there are no limits as to how much your parents can borrow. Applying for a PLUS loan does not require you to complete the FAFSA, though this was stated incorrectly in some past Department of Education publications.

If you absolutely need additional funds to cover college costs, a PLUS loan is certainly a better option than a credit card or high-interest private loan. The PLUS loan has become an even more attractive option for students with few other financial aid resources.

Consolidation Loans

Consolidation loans combine your student loans, usually Stafford, Perkins, or PLUS loans, into one loan order to make it easier for you to repay. If you consolidate your loans, you’ll have to make only one monthly payment to one lender. You’ll also be able to lock in a low interest rate, since Stafford and PLUS loans are variable rate loans. Consolidation loans also offer a diverse number of flexible repayment periods, from 12 to 30 years. Generally, you won’t have to worry about consolidating your loans until you’ve graduated from college.

The Grace Period Loophole

If you are considering loan consolidation, you should be aware that timing is everything. Consolidation loan interest rates are based on the average of all the loans being consolidated. Interest rates for Stafford Loans are actually 0.6 percent lower while you are still a student and during your grace period. This means that if you consolidate your loans before you graduate or before your grace period expires, your consolidation loan interest rate will be set at the lower rate. This 0.6 percent may not seem like much now, but over the course of ten years, it can add up to hundreds—even thousands—of dollars in savings.

Consolidation Loan Drawbacks

If you decide to take advantage of the grace period loophole, keep in mind that once you consolidate your loans, you’re responsible for making payments immediately. You’ll lose any remaining months you may have had in your grace period. Also, any special loan forgiveness benefits offered by the Perkins Loan will be lost once these loans are consolidated. Finally, even though consolidation loans offer extended repayment plans, the downside is that over the life of the loan, your total payments will be higher since you’ll be paying more interest.

The Department of Education has compiled a great number of resources for students interested in loan consolidation. Visit www.loanconsolidation.ed.gov for more information.

 
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