Which Student Loans are the Best Ones to Borrow?

Advice on federal and private student loans.

Mark Kantrowitz

June 11, 2012

Which Student Loans are the Best Ones to Borrow?

I’m a first year and I’m searching for student loans with my mom and I’m not sure which one is the best one I should take out. Do you have any suggestions? — Joanna P.

When comparing student loans, consider both the cost of the loan and the other benefits of the loan program. The cost of a loan is based on the interest rate, fees, subsidized interest benefits and discounts. The other benefits may include deferment and forbearance options, alternate repayment plans and loan forgiveness options.

Students should always borrow federal first, regardless of whether they are undergraduate or graduate students. Federal student loans are cheaper, more available and have better repayment terms than private student loans.

Private student loans, on the other hand, offer variable interest rates, which have nowhere to go but up. Some private student loans now offer fixed-rate options. These fixed interest rates are competitive with federal education loans only for borrowers with excellent credit. Getting the lowest interest rates may require in-school payment of the interest as it accrues and may require a creditworthy cosigner.

Federal education loans do not require cosigners, unlike private student loans, with more than 90% of new private student loans requiring a creditworthy cosigner. A cosigner is a coborrower, equally obligated to repay the debt.

Most private student loans do not have up-front pricing. The only way to tell what the lender will charge you is to apply for the loan. Very few borrowers qualify for a private student loan’s best advertised price. In fact, many more borrowers will get the highest interest rate. Some state loan programs offer lower interest rates than commercial lenders, but this isn’t always the case. There is no way to tell which lender will offer you the best interest rate without applying and comparison shopping. There are a variety of student loan comparison sites, with some providing a comparison of the actual interest rates you will receive.

Private student loans may also lack some of the other benefits of federal education loans. Federal student loans provide more options for financial relief than private student loans. For example, federal student loans offer income-based repayment, which bases the monthly loan payment on a percentage of the borrower’s discretionary income, not the amount you owe. Federal student loans offer public service loan forgiveness, which will forgive any remaining debt after ten years of full-time employment in a public service job while repaying the loans in the Direct Loan program. (The federal Parent PLUS loan does not offer income-based repayment or public service loan forgiveness.) Federal education loans offer the economic hardship deferment for up to three years and forbearances for up to five years, while private student loans usually offer forbearances for at most one year and may charge a fee for each forbearance. Federal education loans also offer extended repayment and graduated repayment.

Loan limits for the federal Stafford loan are lower than the loan limits on federal PLUS loans or private student loans. Dependent undergraduate students can borrow up to $5,500 as a freshman, $6,500 as a sophomore, $7,500 as a junior and $7,500 as a senior. That’s a total of $27,000 for four years; the aggregate limit is $31,000. Independent undergraduate students can borrow up to $9,500 as a freshman, $10,500 as a sophomore, $12,500 as a junior and $12,500 as a senior. That’s a total of $45,000 for four years; the aggregate limit is $57,500. Dependent undergraduate students whose parents were denied a Parent PLUS loan may qualify for the independent student limits. Graduate students may borrow up to $20,500 per year ($40,500 for students in medical school) with an aggregate limit of $138,500 including undergraduate loans ($224,000 for students in medical school). The annual limit on the federal PLUS loan is up to the full cost of attendance minus other aid received, and there are no aggregate limits.

Since the federal Stafford and Perkins loans have lower interest rates, the optimal strategy is to exhaust eligibility from the federal Stafford and Perkins loan programs before resorting to other types of loans.

As a general rule, students who have no choice but to borrow from private student loan programs or the federal PLUS loan program may be overborrowing. Total federal and private student loan debt at graduation should be less than the annual expected starting salary, and ideally a lot less. If total student loan debt is less than the annual income, the borrower will be able to repay the loans in about 10 years. Otherwise the borrower will struggle to repay the loans and may need to rely on alternate repayment plans, such as income-based repayment and extended repayment, in order to afford the monthly loan payments. But this may mean that the borrower will still be repaying her own student loans when her children enroll in college.

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