If scholarships, grants, and work-study aid just are not cutting the mustard and all of your wealthy, overly-generous relatives have gone missing, you have no choice but to turn to...wait for it...student loans. The least desirable form of financial aid, student loans can add up fast, leaving you with a mountain of debt to tackle after you graduate. The even worse news is that, like a bad ex, student loans are almost impossible to shake since they are one of the few forms of debt that cannot be dismissed in bankruptcy. Choose poorly and your student loans could haunt you for much of your post-grad life. Choose wisely and student loans can be a blessing that allows you to get through school in a timely manner without having to worry about whether you can pay for next semester. Here are your loan options:
We have said it once and we will say it again—when it comes to student loans, nobody beats the federal government. In the showdown of federal vs. private loans, the government wins every time for the following reasons:
• Federal loan interest rates are low and they will stay that way. Depending on what type of loan you get (and don't worry, we will break all that down in a minute), interest rates are low, ranging from 3.4 to 6.8 percent for loans available to undergrad borrowers. By comparison, interest rates on private loans can easily inch past 15 percent. Yikes! The bonus Jonas is that federal loan interest rates are fixed, meaning that your payments will stay the same for the duration of your loan. No alarms; no surprises.
• Federal loans are designed to protect the borrower. Government loans come with built-in protections designed to keep the loan in good standing even if the borrower (that is you) runs into trouble. These features include the ability to obtain a loan without a co-signer or passing a credit check, the option to put off paying the loan until after you graduate, and the ability to temporarily defer payments if you hit financial disaster. Private loans may offer some of these options, but these are standard on federal loans students can take out.
• Federal loans have better repayment options. This probably will not mean diddly when you take out the loan, but trust us, having good repayment options will make a HUGE difference once you are paying those bills. Unlike private loans, federal loans come with a wide array of repayment options including an extended plan that can triple the amount of time you have to pay off the debt and a graduated plan where your payments start low then build as you get further in your career.
• You might not have to pay at all. By far the best feature of federal loans is that the government might pay them off for you. Sign up for the income-based repayment plan and Uncle Sam will limit your federal loan payments to 15 percent of your discretionary income, defined as any income above 150 percent of the current poverty line. For 2011, that benchmark is $16,335. That means that if you borrowed $31,000—the maximum Stafford Loan—but land a low-paying job out of college starting at, say, $25,000 a year, your loan payments would be capped at $108 per month. By comparison, students who took out the same amount but did not have an income-based repayment option will pay more than triple per month. Earn less than $16,335 and your monthly loan payments will be $0. Yep, you read that right. Your monthly loan payments will be free. The fiscal fun does not stop there. Under federal guidelines, if you spend 25 consecutive years in loan repayment—even if your monthly payments are capped at nothing—the government will dismiss the rest of your debt. Students who go into public service professions like social work, teaching, and public defense can have their monthly payments capped at 10 percent of their discretionary income and their debt canceled after just 10 years. Regardless of what kind of deal a private lender gives, they will never offer to pay your loan for you.
So now that you know why federal loans are "sweeter than your sister's kool-aid" as Jay-Z would say, let's look at what kinds of federal loans are out there:
The Stafford Loan
The biggest and baddest federal loan out there, the Stafford Loan provides up to $31,000 to all dependent undergraduate students regardless of their financial need. For independent and grad students, the loan limits shoot up to $57,500 and $138,500 respectively. While all students enrolled at least half time in an accredited US institution are eligible for an unsubsidized Stafford Loan (meaning the interest comes out of your pocket), students demonstrating financial need are eligible for a subsidized Stafford Loan (meaning the government pays the loan interest while you are in school). The good news for students both with and without financial need is that the Stafford Loan is affordable...really affordable. For the 2011-2012 school year, the Stafford Loan has a fixed interest rate of 3.4 percent, making it THE best deal on student loans out there. There is just one tiny hiccup—students cannot pull all $31,000 out at once. The Stafford Loan comes with annual loan limits that correspond with how far along you are in school. Undergrads can take $5,500 for their first year of college, $6,500 for their second year, and $7,500 for each year after up until they reach the $31,000 maximum. Unfortunately $5,500 probably will not cover a full year of college unless you are attending a two-year institution or technical school. While the Stafford Loan is a rock star in the student loan world, it could leave you high and dry.
The Perkins Loan
Where the Stafford Loan drops off, the Perkins Loan steps in...sometimes. Only available to students with exceptional financial need, the Perkins Loan provides an additional $27,500 for undergrads and up to $60,000 for grad students. Perkins interest rates are capped at 5 percent, but yearly limits still apply. Undergrads may only borrow up to $5,500 per year, meaning that if students apply for need-based aid and max out both the Stafford and Perkins Loans, it still might not be enough to cover tuition at pricier institutions.
The Parent PLUS Loan
And here is where you ask mom and dad for help. If the federal government will not lend you enough to attend the school of your dreams, they will probably hand the rest over to your 'rents. With the Parent PLUS loan, families can borrow up to the total cost of attendance, but unlike other federal loan programs, they will have to pass a credit check to get their hands on the cash. The Parent PLUS interest rate is capped at 7.9 percent (6 percent for parents in the military), but when repayment time rolls around, parents (not students) are legally responsible for forking over the cash.
If financial aid and federal student loans are not enough to fund your education AND if your parents won't sign on to a Parent PLUS loan, private loans may be your only option. The private student loan market is a bit like the Wild Wild West—some lenders offer reliable loan products, but some vigilante lenders make their own rules and take advantage of students who have no other financial alternatives. If you do go the private loan route, do so only after maximizing your federal loan options, comparison shop between several lenders before deciding on one, and make absolutely sure that you have read the fine print before signing on the dotted line.