How to Score a Loan for College
By: Anne Tergesen
BusinessWeek
With lenders dropping out of the business due to credit-crunch stress, students and their parents should study up on these options…
Families struggling to pay for college need all the help they can get. With lenders spooked by the credit crunch abandoning the business, borrowers seeking loans for the coming academic year may encounter problems, including higher interest rates on some loans, and lenders that balk at lending to any but the most credit-worthy.
Your Loan Choices
There are two types of college loans. Federally backed loans include the Stafford for students and the PLUS for parents and graduate students. Private loans are not federally backed. For that reason, they tend to be more expensive and should only be used as a last resort. Parents can also borrow using a home-equity loan or line of credit.
Federal Loans
Because federal loans are less expensive than private loans, borrow up to the maximum you’re eligible for before considering a private loan. With a Stafford loan, an undergraduate can currently borrow up to $3,500 for freshman year, $4,500 sophomore year, and $5,500 annually thereafter, for a total of $23,000. Parents can then follow with a PLUS loan for the balance of what’s owed for tuition, room and board, and fees—or if they choose, up to the full cost of attendance.
Stafford loans charge a maximum fixed rate of 6.8%, while PLUS loans charge 8.5%. These loans have other advantages: Anyone can qualify, regardless of income, and borrowers who encounter financial hardship can request repayments be suspended or reduced.
Apply for a Federal Loan
The first step is to fill out the paperwork. Start with the Free Application for Federal Student Aid (FAFSA) at fafsa.ed.gov. Even those who don’t qualify for aid should fill it out, since FAFSA is a requirement for government-backed loans. In addition, you’ll have to complete an application for each loan for which you apply.
Compare the Benefits
The first step is to fill out the paperwork. Start with the Free Application for Federal Student Aid (FAFSA) at fafsa.ed.gov. Even those who don’t qualify for aid should fill it out, since FAFSA is a requirement for government-backed loans. In addition, you’ll have to complete an application for each loan for which you apply.
Most Stafford and PLUS loans feature at least one of three types of discounts: fee waivers, principal reductions, and interest-rate reductions. To crunch the numbers, use the calculator at FinAid (finaid.org/calculators/loandiscountanalyzer.phtml). It factors in the effect of fee reductions and other discounts and comes up with a “discounted interest rate.”
As a rule, favor discounts that kick in early in the life of a loan and cannot be canceled. Discounts contingent on good behavior—such as paying on time for the first 48 months—are less valuable. Fewer than 10% of borrowers ever qualify.
Private Loans
Many families use private loans to bridge the gap between the rising cost of college and the maximum students can borrow in Stafford loans. Some choose them over PLUS loans because private loans leave the student, rather than the parent, on the hook for repayment. Private loans generally have variable rates, which now range from 6% to 16%. The rate a borrower will pay depends in part on his or her credit score. Fees on these loans can be as high as 11.5%.
Where to Find Private Loans
Ask your school’s financial aid office for a recommendation. Some schools negotiate special deals. Then check with state-affiliated nonprofits, such as South Carolina Student Loan Corp. or the Massachusetts Educational Financing Authority (MEFA). Since the credit crisis hit, several of these lenders have suspended at least some student loan operations, but those still making loans tend to offer competitive rates and fees.
Compare Loan Rates
Don’t simply pick the lender advertising the lowest rate. The percentage all but the most creditworthy consumers pay will be higher than what’s publicized. Fill out applications with more than one lender, but since each new application can reduce your credit score by five points, only apply to three or four lenders total—and do so within a period of a few days
Do You Need a Co-signer?
Because the interest rates on private loans depend mainly on a borrower’s credit score, even students with relatively sound credit can typically benefit from having a relative or friend with a more established credit history co-sign the loan’s promissory note. Co-signers should know that they are on the hook for repayment should the student default.
Look for Discounts
Due in part to the credit crunch, lenders are reducing discounts they offer on rates and fees. But borrowers who agree to make payments while in school may still qualify for a lower interest rate.
Set Up a Backup Plan
Many lenders have left the business due to the credit crisis. If you have already taken out a student loan, check to see if your lender is still in the business. Have a backup, in case your top choice decides to drop out. Larger banks are least likely to get out of the business since they can rely on customer deposits as a source of funds.
Refinance Your Loans
Those who want to refinance or consolidate their loans by combining variable-rate federal loans to lock in a fixed-rate loan, should wait until after July 1, when the rates reset. Why? Rates are likely to fall by a significant amount from today’s level. But with lenders representing a large chunk of the consolidation market having left the business, your lender may no longer offer this service. You can always consolidate through the federal government at www.loanconsolidation.ed.gov.