The other day I received an email that asked the following question:
“My daughter is getting ready to go to college in the fall. Do you have any advice on student loans?”
Because every situation is different, it is very difficult to provide definitive advice. It would be like walking into a guidance counselor’s office and asking, “What college is best for me?”
What I can do is offer some ideas and thoughts to consider. Think of this advice as a beginners guide to student loans, or the student loan basics.
Are you paying too much for college?
The first thing you will want to consider before you get a single loan is whether or not you have minimized your college expenses. Student loans can be brutal. Have you applied to every scholarship? Is there a less expensive alternative to the school you are thinking about attending? Have you tried to squeeze every dime you can out of your financial aid office? Have you lined up employment to cover your expenses?
Should I get Federal Loans?
The next question to ask yourself is whether or not you want federal loans. For almost everyone, federal loans are superior to anything offered on the private market. Anyone can get federal loans, regardless of income level. It doesn’t matter if your parents make a ton of money or if you have bad credit. (Note: there are some bad credit limitations on federal student loans, but the federal loans are far more accepting of bad credit or no credit history than private lenders.)
In order to get federal loans, get your FAFSA on file and make sure you complete whatever school specific forms your financial aid office may have.
If you are wondering what makes the federal loans better, here are some of the reasons:
- They are easier to qualify for.
- They have much better repayment plans.
- Federal loans offer student loan forgiveness programs.
- Federal loan interest rates are very competitive.
- Federal loans offer the most straightforward terms and conditions.
What should you look for in a student loan?
A student loan is a complicated financial contract between you and your lender. These terms can vary greatly from one lender to the next, so it is critical you are on the lookout for certain provisions.
You should know the answers to the following questions before you sign for a loan:
- Is there a loan origination fee? (Many lenders will charge you 3% right off the top.)
- Is the interest rate fixed or variable?
- If you have a variable rate, how high can it go?
- If you have a variable rate, what has to happen for your rate to go up or down?
- Are there any prepayment penalties with your loans?
- What repayment plans are available?
- What happens if you are unemployed?
- How often is interest compounded?
Special Note for the 2013-2014 school year: Due to the low interest rates in the current economy, a fixed rate loan is likely the best alternative. Unless you plan on paying back your loan very quickly (such as within a year or two), the fixed rate loan will save you money in the long run.
What should you do about your student loans during school?
In addition to minimizing how much you spend on college, earning some money to pay just the interest on your loans is a great idea. Not only will this save a bunch of money in the future, but it gives the student a good idea of what life will be like upon graduation.
Tip for Parents: If you are paying for part of school or cosigning on a loan for your child, you may want to make your help conditional upon your child working part-time during school. Quiz your child on the terms and conditions of the student loan that they want to get. Most new college graduates have no experience making a budget and they have no idea how much they will be spending to pay back their student loans. You do not want this to happen to your child! There is a 6-month “grace” period after graduation on most student loans. During this time period, the bank is making money on compounding interest and Junior is deciding whether or not to splurge on the fancy new apartment or new car. If your child makes interest payments during school, they will have a much better appreciation about the dangers of the huge post-graduation purchases.
A final word of advice…
Do the Math.
I know that doing math is neither fun nor sexy, but it is the most important thing when it comes to college finance decisions.
Are you majoring in basket weaving, art history, or philosophy? What does the average graduate from your program make? Can you realistically pay back the loans that you are taking out?
Many people graduate only to find out that their income doesn’t nearly support their loan payments. Student loan delinquencies are at an all time high. A delinquent student loan destroys your credit. That means no house purchase, no new car, and no chance of refinancing your loans. Don’t learn this lesson the hard way! Plan ahead, have a Plan B and a Plan C, and protect your financial future.
Student loans are incredibly difficult to get rid of in bankruptcy. Unlike buying a car or house that you can’t afford, there is no recovering from buying an education that you cannot afford. Many students will borrow enough student loan money to pay for a house! Paying back these loans can take decades.
Before you sign anything, put in the time and effort to make sure you are making the best possible decision.