How to Choose the Best Student Loans
By Mark Kantrowitz
When choosing student loans, students and their families should focus
first on the cost of the loan. This can affect the monthly payment and
the total payments over the life of the loan. The best loans are the
lowest-cost loans.
Also important is the availability of repayment options for borrowers
who encounter short-term and long-term financial difficulty, such as
deferments, forbearances and alternate repayment plans. Other
considerations may include who is responsible for repaying the debt
and the quality of customer service.
Some borrowers choose the lender with the most familiar name, such as
the lender with the greatest brand recognition nationally or in the
borrower's geographic region. Others choose the lender that is listed
first on a college's preferred lender list. These lenders do not
necessarily offer the lowest-cost loans. It is best to shop around, as
rates and fees may vary by lender. Sometimes, a less well-known lender
will offer the lowest-cost loans.
Lowest Cost Loans
When considering the cost of the loan, it is best to shop around for
the loans with the lowest interest rates and fees. Although federal
student loans have up-front pricing, many private student loans do
not. Instead, the interest rates and fees are personalized based on a
variety of factors, such as the credit scores and credit history of
the borrower and cosigner. In some cases, the lenders will also
consider the student's college, grade point average (GPA), year in
school, degree level and academic major.
When shopping around for the lowest cost loan, do not rely on the
advertised interest rates and fees. The best advertised rate is not
necessarily the rate you'll get. The best advertised interest rate is
received by less than 5% of borrowers. The only way to know what
interest rate you'll get is to apply for the loan.
It is best to focus on the interest rates and fees, not the monthly
loan payment. Beware of comparing loans with different repayment
terms, as a longer-term loan will have a lower APR and lower monthly
loan payment, despite charging more interest over the life of the
loans. For example, the monthly payment on a $10,000 loan with 10%
interest is $96.50 on a 20-year term, lower than the monthly payment
on a $10,000 loan with 5% interest on a 10-year term. But, the total
payments over the life of the 20-year loan is about $23,162, much more
than the $12,728 total payments over the life of the 10-year
loan. Focusing on just the monthly payment may give a misleading
perspective of the cost of the loan. If you are comparing several
loans based on the monthly loan payment, also compare the total
payments over the life of the loan.
| Impact of 1% Increase in Interest Rate |
|---|
|
| 10-Year Term | 5% |
| 20-Year Term | 9% |
| 30-Year Term | 12% |
The following factors affect the cost of the loan:
- Interest Rate. Although the loan with the lowest interest
rate will usually be the lowest-cost loan, the cost can be influenced
by other factors.
- Subsidized Interest. The Federal Perkins loan and
subsidized Federal Stafford loan have subsidized interest, where the
federal government pays the interest during the in-school and grace
periods and other periods of authorized deferment. Subsidized interest
is like having a 0% interest rate for a fixed period of time.
A subsidized loan is the equivalent of an unsubsidized loan with a
lower interest rate, if interest on the unsubsidized loan is
capitalized during the in-school and grace periods. Assume a 45-month
in-school period and a 6-month grace period. Subsidized interest is
the equivalent of an unsubsidzed loan with half the interest rate on
a 10-year repayment term, two-thirds the interest rate on a 20-year
term and three-quarters the interest rate on a 30-year term.
- Fixed vs. Variable Interest Rates. A fixed interest rate
remains unchanged for the life of the loan. This will yield the same
monthly payment every month. A variable interest rate, on the other
hand, may change periodically. If the interest rate increases, the
monthly payment increases. In today's low interest rate environment,
variable interest rates have nowhere to go but up. If interest rates
are expected to increase, variable-rate loans should be avoided unless
the borrower plans on paying off the loan early, before interest rates
increase too much. Assuming a 10-year term, a variable interest rate
will be about 3 or 4 percentage points lower than the equivalent fixed
interest rate.
- Loan Fees. Loan fees are a form of up-front
interest. Avoid loans that charge fees if you plan on paying off the
loan early. Loan fees of 4% are the equivalent of a percentage point
(1%) increase in the interest rate on a 10-year term and half a
percentage point (0.5%) increase in the interest rate on a 20 or
30-year repayment term. Most private student loans have no fees.
- Loan Forgiveness. Loan forgiveness programs cancel all
or part of the student loan, thereby affecting the cost of the
loan.
The next two tables rank the most common types of student loans according to cost.
This table ranks the lowest-cost loans for undergraduate students for
the 2015-2016 award year. Interest rates and fees are subject to
change on or after July 1, 2016.
| Lowest-Cost Loans for Undergraduate Students |
|---|
|
| Federal Perkins Loan | Fixed 5% | Yes | No |
| Subsidized Federal Stafford Loan | Fixed 4.29% | No | No |
| Unsubsidized Federal Stafford Loan | Fixed 4.29% | No | No |
| Federal Parent PLUS Loan | Fixed 6.84% | No | Yes |
| Private Student Loan | Fixed or Variable | No | Yes |
This table ranks the lowest-cost loans for graduate and professional
school students for the 2015-2016 award year. Interest rates and fees
are subject to change on or after July 1, 2016.
| Lowest-Cost Loans for Graduate and Professional School Students |
|---|
|
| Federal Perkins Loan | Fixed 5% | Yes | No |
| Unsubsidized Federal Stafford Loan | Fixed 5.84% | No | No |
| Federal Grad PLUS Loan | Fixed 6.84% | No | Yes |
| Private Student Loan | Fixed or Variable | No | Yes |
Dealing with Financial Difficulty
Private student loans generally do not have as good provisions for
dealing with financial difficulty as federal student loans. These
benefits provide alternatives to defaulting on the debt.
- Death and Disability Discharges. These discharges cancel
the remaining debt upon the death of the student or primary borrower
or upon the total and permanent disability of the primary borrower.
- Deferments and Forbearances. Deferments and forbearances
are good options for short-term financial difficulty. They provide
temporary suspensions of the obligation to repay the debt. Interest
continues to accrue and will be capitalized (added to the loan
balance) if unpaid. During a deferment, the federal government pays
the interest on subsidized loans, but not unsubsidized
loans. Deferments and forbearances have a total duration of up to
three years for federal student loans, but only one year for private
student loans.
- Alternate Repayment Plans. Federal student loans offer
numerous alternate repayment plans for dealing with long-term
financial difficulty. These include extended repayment, graduated
repayment and income-driven repayment (e.g., income-contingent
repayment, income-based repayment, pay-as-you-earn repayment and
revised pays-as-you-earn repayment). Most private student loans do not
offer income-driven repayment plans.
- Default. A federal student loan is considered to be in
default after 360 days delinquency, compared with 120 days for a
private student loan.
- Loan Rehabilitation. A defaulted federal student loan
can be rehabilitated (restored to a current status) if the borrower
makes 9 out of 10 consecutive, full, voluntary monthly
payments. Defaulted federal student loans can also be rehabilitated by
consolidating the loans into the Federal Direct Consolidation Loan
program, if the borrower agrees to repay the loan in the income-based
repayment plan. Private student loans do not offer similar
options.
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