After spending years helping people manage their student loans and recover from student loan disasters, we have developed some strong opinions on borrowing strategy during school.
All student loans come with risk, and circumstances may require adding student debt to the college equation. However, question number one for any student and/or their family to consider is whether or not borrowing a student loan is a good idea.
Should I Borrow a Federal Government Loan or a Private Student Loan?
One of the biggest mistakes that a student can make is borrowing private student loans instead of federal government student loans.
Extensive borrower protections are the reason that federal student loans are a much better option. In addition to a number of student loan forgiveness programs, there are also repayment plans that charge borrowers based upon how much they can afford rather than what they owe. These borrower protections help borrowers avoid desperate student loan dilemmas.
The vast majority of college students expect to earn more money as a result of their studies. Unfortunately, some of these students will not ever graduate. Others won’t find a job in their field of choice. Others may choose less lucrative but more meaningful work. The wide variety of potential outcomes makes it important to choose flexible student loan options.
The problem with private loans is their unforgiving nature. Many lenders have little patience for late or missed payments. Making things even more complicated is the fact that bankruptcy from student loans is nearly impossible under the current rules. Borrowers who owe more than they can ever afford may end up making student loan payments for life. They also run the risk of never having a decent credit score.
With high stakes and an uncertain future, federal loans are clearly the better option.
The only time a private loan might make more sense is for a borrower who plans on quickly paying back their debt and zero concern that they will be able to afford the loan. An example might be a non-traditional student going back to school for a few classes.
Absent a situation where repayment is a certainty, federal loan flexibility outweighs even the best interest rate offerings on private loans.
The Differences Between Federal Subsidized Loans and Unsubsidized Loans
Put simply, with a subsidized loan, the government pays the interest on the debt during school and in a few other limited circumstances. Unsubsidized federal loans mean that the borrower is on the hook for all of the interest.
As one might expect, getting subsidized loans is more difficult than getting an unsubsidized loan. The good news is that it is only slightly more difficult.
The first big limitation on subsidized student loans is that the federal government imposes much lower borrowing limits.
The other major limitation is that a student must demonstrate a financial need to get a subsidized federal loan. That being said, the applications for both types of loans are identical. Students and their families must complete the FAFSA. Students from families with limited income may qualify for subsidized loans, while even the super-wealthy are eligible for unsubsidized loans. Should the children of Bill Gates or Kanye West ever need student loans, they would still be eligible for federal student loans if they complete the FAFSA.
Should I get a Parent PLUS Loan or Co-Sign a Private Student Loan?
Parent PLUS loans are federal student loans, but they are very unique. Instead of being borrowed by the student, the loans are borrowed by the parent. At the time of paying for college, this difference may seem small, but in repayment, it is a major difference. The loan is in the parent’s name, and the parent is responsible for the debt. Some families end up having major personal and financial hardships when the parent expects the child to pay and the child expects the parent to pay. The debt collectors will expect the parent to pay.
Another major difference between a parent PLUS loan and most other federal student loans is that the interest rate and fees associated with the loan are higher. At present, the interest rate is 7.08%, and the loan origination fees are over 4%.
Making things more complicated is that the Parent PLUS repayment plans are more limited than the options for other federal student loans.
These higher rates and fees combined with more limited options make Parent PLUS loans noticeably different than other federal student loans. Families should probably treat Parent PLUS loans as a viable option, but it isn’t the no brainer that other federal loans are.
The option that many parents consider in place of a Parent PLUS loan is to co-sign their child’s private loan. Often students lack the credit history to qualify for a private loan on their own, hence the reason a parent co-signer may be needed.
The PLUS loan has high costs associated with it, but some federal protections. A co-signed private loan will appear on the credit report of both parent and child (because both would be legally responsible), but it may have a lower interest rate.
Deciding between these two options can come down to the parent’s ability to pay for the debt. If there is a concern that mom or dad might not be able to afford the monthly payments, it might be safer to go with the Parent PLUS loan and all of its warts.
Graduate PLUS Student Loan Options and Alternatives
For students going after a graduate degree, the Graduate PLUS loan can be a great option.
The downside is that like the Parent PLUS loans, the interest rates and loan origination fees are higher than most other federal student loans. The good news is that unlike a Parent PLUS loan, Graduate PLUS loans have a wider variety of repayment plans and forgiveness options.
For most graduate students the choice comes down to a Graduate PLUS loan or a private loan. In most cases, the Graduate PLUS loan is the preferred alternative.
Even though the Graduate PLUS loan does have higher interest rates, these costs can largely be justified due to the federal protections. Many graduate students borrow upwards of $100,000. If there is any sort of uncertainty in the job market or borrower’s ability to pay, having student loans with forgiveness provisions is a huge security blanket.
Private loans start to make sense for those that have a high degree of confidence in their ability to repay. An example would be someone returning to school to get an MBA at night. Borrowing can be minimized, and the student’s current salary may be sufficient to handle future loan payments.
Selecting the Best Private Student Loan
Reaching the conclusion that a private student loan is the only way to pay for college can be scary. The risks are higher, but if the gamble pays off, it can lead to a valuable degree and a bright future.
Students making the decision to choose a private student loan should know that these loans are not all created equal. Some private student loans are far better than others.
Because there are a number of lenders offering these loans, students should insist that they not be charged any loan fees, such as an origination fee or is disbursement fee. Students should also be sure to shop around to get a low interest rate loan. A difference of even a fraction of a percent can add up to a lot of money by the time the loan is repaid.
One important detail to understand is that the rates advertised by lenders are not necessarily the rates that will actually be offered. Most lenders have their own unique criteria for evaluating applications, and each lender may give different weights to credit history, school, and area of study. Companies like credible can help students compare rates with a number of lenders. The key is to cast a wide net.
Even if a student is able to find an excellent loan, it is still critical to only borrow that which is absolutely necessary. If you are living off private student loans, you should be careful to keep expenses as low as possible.
Borrowing Money When Student Loans are Not an Option
A common question that we receive is from students who are not able to get any student loans. They want to know what the next best option is to pay for school. This situation normally occurs because they have borrowed the maximum estimated cost of attendance as determined by their school or because they cannot qualify for any more student loans.
In either scenario, the difficulty of getting a student loan should be a huge red flag. Either the school is saying that it shouldn’t cost that much to attend, or lenders are unwilling to provide money because they don’t think they will get paid back. These large institutions are skilled at evaluating risk, so students should take the denials and rejections seriously.
Is there a less expensive alternative? Can the office of financial aid provide additional scholarships or grants? Is the school attended worth the cost?
Those that are truly desperate normally have to turn to a personal loan when all other student loan options do not exist. Personal loans normally have higher interest rates, and repayment starts immediately. Rarely is this route advisable.
Picking the Best Student Loan
The best student loan is to not get a student loan.
The second best student loan is one that is well researched and compared against the available alternatives. With a variety of federal and private loans to choose from, it is critical to spend some time evaluating the pros and cons of the possible choices. The work isn’t hard or time-consuming, but it is essential to smart borrowing.
Editor’s Note: This article was originally published September 2nd, 2018. It has been updated to include federal interest rates for the 2020 school year.