If your child is a senior in high school we don’t have to tell you that it’s now the season for college financial aid. This means that among other things if you haven’t yet completed and submitted your FAFSA (Free Application for Federal Student Aid), you need to get cracking – even if you’re not yet sure whether or not federal aid will be the best option for your child. Most students do choose to get federal aid because the loans provided by the US Department of Education generally have the best interest rates and offer a number of attractive repayment options. But today, some of the banks that provide private student loans have made changes that make their loans more appealing. This can be especially true if you or your parents are creditworthy. In this case a private loan might have a better interest rate than those of federal loans.
Why have the private lenders made changes in their loans?
There are several reasons for this. First, there has been a lot of pressure on these lenders to make changes. Second, it’s because they are looking to attract young customers that may be with them for their lifetimes and will eventually need mortgages and other financial products. Some of these lenders are now offering refinancing options that can actually lower the interest rate on student loans as well as modifications designed to help those of their borrowers that are having a tough time making their payments.
When you should get federal loans
If you’re borrowing on your own with no help from your parents, your best bet will always be federal loans. They’re cheaper because everyone gets the same fixed rate. Also, as mentioned above they have better repayment terms. If after you graduate you find that you are unable to repay your loans because you’re unemployed or have a low salary, you could qualify for repayment options that would keep you out of default. Also, federal loans could be a much better choice if you find you need to modify your payments after you graduate. Are you going to school to become a teacher or social worker? Federal loans offer a number of benefits including loan forgiveness in public-service jobs. With this translates into is that you would not have to pay back the full amount of whatever you borrow.
Hope you’ll get subsidized loans
The best federal loans are those that are subsidized. This means that while you’re in school the federal government will pay the interest on them. This includes both Stafford loans and Perkins loans. However, they are needs based meaning that you will have to demonstrate a financial need. If you qualify you could get a subsidized Stafford loan for the next school year where your interest rate would be just 4.66% plus an origination fee. However, be aware that there will probably be an interest increase on Stafford loans so that Perkins loans may once again be the cheapest federal education loan.
When a private loan might make sense
If your parents have a credit score of around 740 on the FICO scale a private loan might make sense. The reason for this is that if your parents were to get a Parents PLUS loan or if you’re a graduate student and need one of these loans the interest rate will be 7.21% plus an origination fee. If you go to a private lender you should qualify for a better rate. Be sure to note whether the loan has a fixed or variable interest rate. One of the best things about federal loans is that their rates are fixed. On the other hand, loans from private lender have both fixed and variable rates. The variable rates are the lowest just as they are with variable rate mortgages. However, this means the interest rate could increase in the years ahead. If you want a ballpark estimate of the interest rate you would pay over the lifetime of the loan just add four percentage points to the variable interest rate you’re being offered.
Compare the fees
There is currently a 1.073% origination fee for Stafford loans and the origination fee for a Federal PLUS loan is 4.29%. In comparison, most private loans don’t charge any fees these days. So if you were to amortize 4% in fees over a 10-year period, it will come out about the same as if you were to pay a 1% higher interest rate.
Things to keep in mind about federal loans and their repayment options
If you get a federal loan, you may be able to postpone repayment for three years or longer through what’s called deferment or forbearance – assuming you have a financial hardship such as medical expenses or unemployment. If you are unable to pay your monthly bills in full because of low income, you could apply for Income-based repayment or Pay As You Earn repayment. Income-based repayment would cap your monthly payments at 15% of your discretionary income while Pay As You Earn would cap them at 10% of your discretionary income. For that matter, if were unemployed, your monthly payment would be zero because 10% of nothing is nothing.
Refinancing federal loans
A few banks and non-banks are now offering to refinance any combination of private and federal loans. But if you were to consolidate your federal and private loans into one of these new loans you would give up all the benefits offered by federal loans such as debt forgiveness for public service jobs and income-based repayment programs. The upside is that you might be able to get a better interest rate by consolidating federal student loans through a private lender than with a Federal Direct Consolidation Loan.
Which makes the most sense if you’re a parent?
It doesn’t make much difference whether you cosign on a private loan for your child or get a parent’s PLUS Loan, you’ll still be required to take over the loan or loans if your child can’t or doesn’t make the payments. So that means as a parent you would be on the hook either way. On the other hand if your child takes out federal student loans only he or she will be responsible for repaying them and you as the parent will be off the hook. So no matter how tempted you might be to cosign on a loan or take out a Parent PLUS loan, it’s really better for you financially to let your child get the loans. This can be especially true if you’re nearing retirement. Students today are graduating with an average of nearly $30,000 in student loan debts and that’s probably a burden you might not want to assume as you near those golden years. You could always choose to help your child repay his or her federal loans when and if it makes sense to you financially. But you would not be committed to repaying that $30,000 or whatever.