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:
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.
Loans not based on need generally have higher interest
rates and stricter repayment options than need-based 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.
With unsubsidized loans, you are responsible for any accrued
interest as soon as the loan is issued.
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.
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.
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.
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 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.
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
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
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
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
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.