Best and Worst Student Loans: Pros and Cons

    Student Loan OptionsThe pros and cons of student loans are a hot topic for college administrators, students and parents as each side grapples with ways to absorb the soaring cost of earning a degree.

    Tuition and fees at public universities have risen an average of $2,790 the last 10 years, an increase of over 40%. Add in the cost of room and board, and students enrolled in 2016-17 forked over $20,090 a year to attend a public university and $45,370 for a private college.

    That makes it more important than ever to understand what types of loans work best for you. The average college graduate in 2016 owes $37,172, so do the research to keep your repayment options open.

    Be especially mindful of changing interest rates. The rates for federal loans are set by Congress and fixed for the life of the loan. The rates for 2017 ranged from 4.45% for Direct Loans to 6% for graduate and professional loans to 7% for Direct PLUS loans.

    Those interest rates were slightly higher than in 2016, but lower than 2014. That’s important because higher interest rates, even half a point, can cost you thousands of dollars in difference when you pay it back over the standard repayment period of 10 years.

    While private student loans are considered a last resort for all borrowers, if you intend to go that route, it is wise to improve your credit score before applying and to shop around to various banks and credit unions. Private lenders are making more of an effort to get competitive on interest rates, but it will take research to find the deals that could reduce your loan costs.

    Avoid Loans If Possible

    The best financial move for every college student is to explore ways to pay for school without loans. The fact that 73% of 2017 college graduates had student loan debt shows that is difficult, but there are some steps you can take to minimize, if not eliminate loans.

    • File a Free Application for Federal Student Aid (FAFSA) [link FAFSA changes story]. You won’t be able to apply for federal grants or federal student loans without filing a FAFSA first.
    • Pay as much of your tuition with grants and scholarships as you can. This is free money, which means you don’t have to pay it back. Before you think about student loans, use your grant and scholarship money.
    • Rely first on federal loan money. Federal loans are funded by the U.S. government. They offer fixed-interest rates that are lower that private loans and have flexible repayment options that private lenders don’t offer.
      • Start with Subsidized Direct Loans and Perkins Loans if you qualify (must demonstrate financial need).
      • Supplement remaining college costs with unsubsidized federal loans. Interest accrues while you’re in school, but rates are still better than private loans.
      • Avoid PLUS loans, as they have higher interest rates (31% in 2017) and high origination fees (4.276%).
    • Use private student loans as a last resort. These are controlled by banking institutions and offer few flexible repayment plans. Banks may offer lower promotional interest rates, but these are contingent on excellent credit scores. They may have variable or fixed rates, but know that a variable rate can increase at any time.

    Which Student Loan Is Best for You?

    Subsidized Direct Loans

    These federal loans have a fixed interest rate and the government pays your interest while you’re in school. You must show financial need.

    PROS
    • Interest rate is fixed at 4.45% in 2017-2018 for undergraduate students.
    • Interest is paid until you graduate.
    • Credit history is not a factor.
    • Repayment grace period after graduation is six months.
    CONS
    • Strict limits on amount you can borrow ($3,500-$5,500 per year).
    • Students must demonstrate financial need.
    • Not available to graduate students.
    • 069% origination fee taken out for each disbursement.

    Perkins Loans

    Colleges lend students federal money to pay for school.

    PROS
    • Available to undergraduate and graduate students.
    • No origination fees.
    • Interest rate is fixed at 5%.
    • Interest is paid until you graduate.
    • Repayment grace period after graduation is nine months.
    • Could have up to 100% of loan forgiven for service as teacher in math, science, foreign languages or special education, firefighter, police, nurse.
    CONS
    • Not all schools participate in the Perkins Program.
    • Only available to students with exceptional financial need.
    • Amount received depends on amount of Perkins Loan money your school has available (eligible recipients may not get loan money if funds run out).

    Unsubsidized Direct Loans

    While these also carry a fixed interest rate, you’re responsible for repaying all the interest that accrues while in school.

    PROS
    • You don’t have to demonstrate financial need.
    • Fixed interest rate in 2017-2018 is 4.45% for undergraduates and 6% for graduate students.
    • Credit history is not a factor.
    CONS
    • You’re responsible for paying interest throughout the loan period.
    • If you don’t pay interest while in school, during grace periods and the deferment or forbearance periods, the interest will accrue and be added to the original loan amount.
    • 069% origination fee taken out for each disbursement.

    Direct PLUS Loans

    Allows parents of undergraduate students or non-dependent graduate students to borrow money.

    PROS
    • Parents can help students pay for education.
    • Interest rate is fixed at 7% in 2017-2018.
    • Parents can defer payments while student is in school, and up to six months after they graduate.
    • Gives graduate students the option to pay for education.
    CONS
    • Credit history is a factor.
    • Loan payments may distract parents from saving for retirement
    • Borrower is responsible for paying back interest.
    • PLUS Loans made to parents cannot be consolidated.
    • 276% origination fee taken out for each disbursement.

    Direct Consolidation Loans

    Borrowers can consolidate all of their federal loans into one monthly payment.

    PROS
    • Gives borrower one bill to pay each month instead of multiple bills.
    • Consolidation offers several flexible repayment plans
    • Often lowers monthly payments, giving borrowers up to 30 years to pay loans back.
    • Consolidation may give borrower the option of switching variable interest rate loans to a fixed interest rate.
    • Consolidation is usually not an option for private loans.
    CONS
    • Increasing payment length can also increase the amount of interest you pay over time.
    • Consolidation may result in the loss of benefits the original loans offered including: discounted interest rates, principal rebates or loan cancellation benefits.
    • PLUS Loans made to parents cannot be consolidated.

    Private Loans

    Money is lent to borrowers by private institutions like banks, credit unions and state agencies. There is wide variety of offerings from private lenders and needless to say, it pays to shop around. Be sure to ask about fees, deferred payments or interest rate reductions attached to your loan.

    PROS
    • Private lenders allow people to take out larger amounts.
    • Can supplement costs not covered by federal aid.
    • Loans are usually disbursed immediately after approval.
    • Many private loans don’t have origination fees.
    • Funds can be used for education expenses beyond tuition, books and housing.
    • Finding a co-signer could improve the interest rate on your loan and co-signer can be released from loan obligations after a period of on-time payments.
    CONS
    • There are no subsidized private loans.
    • Each private lender has different rules for their loan repayment plans (many are rigid.)
    • Some private lenders require loan payments to begin while the borrower is still in school.
    • A good credit history matters. The amount of interest you pay for your loan depends on your credit score.
    • Private loan interest is not tax deductible.
    • Private loans generally cannot be consolidated, except under extreme circumstances.
    • Few private lenders offer loan forgiveness or income-based repayment.

    Situations Where One Type of Student Loan is Better Than Another

    Federal loans usually offer relatively low interest rates and don’t require a credit check (except PLUS Loans) or a cosigner. A borrower can have the option of having all their federal loans consolidated into one lump sum for repayment purposes. Depending on your profession, the federal government may even forgive the loans if certain conditions are met.

    • Subsidized Direct Loans: People thinking of working public service jobs (federal, state or local government) may want to look into these as they may have their remaining balance forgiven.
    • Unsubsidized Direct Loans: Students not facing a financial hardship, who need to borrow more than the cap on subsidized loans, may also want to look at these because you may be eligible for up to $2,000 more a year. These may be good for students who are not considered “dependents” or have parents who didn’t qualify for a PLUS Loan.
    • PLUS Loans: Financial experts say PLUS Loans should be considered after the student’s Direct Loan options are exhausted. Parents of students in private universities often look at PLUS Loans to supplement the cost. The 7% interest they carry may be cheaper than some private loans.
    • Perkins Loans:People considering fields such as teaching, law enforcement, and the military may have part or all of their loans cancelled based on years of service.
    • Private Loans: This type of aid is generally best for people with good credit, established credit histories who can’t apply for federal aid, can’t receive a scholarship or grant, or tapped out what they can receive from the government.

     What Are the Best Private Student Loans?

    Finding the best private student loan depends on how well you shop around.

    If you’re looking to take out a private loan, you should consider certain factors:
    • Interest rates
    • Flexibility
    • If lender can release co-signer once you’ve proven you can make on-time payments over a specified length of time.
    • Years the lender has been working with student loans.
    • Does the lender sell its loans?
    • Repayment benefits

    Another way to potentially find a good deal on a private student loan deal is to ask if your college or university of choice provides a list of preferred or suggested lenders.

    Private lenders lists are usually found on a school’s website. Universities and colleges are required to explain why they made their selections. It would be good for your family to review them before taking out a private loan.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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