Wednesday, June 15, 2011
Watch your money.
One student loan charges an interest rate of 3%. Another charges 6.8%. Which should you choose?
There are two types of student loans: federal loans, which are issued directly by the federal government, and private loans, which are provided by banks and other lenders. Most borrowers who take out federal student loans will pay a fixed rate of 6.8%. Students who qualify for subsidized loans, which are awarded based on financial need, will pay a fixed rate of 3.4% on loans issued after July 1.
Interest rates on private loans vary, depending on the lender and the borrower's credit rating. In recent months, though, rates on these loans have dropped. In April, for example, lending giant Sallie Mae reduced rates on its private loans to as low as 2.25%.
Lenders are sweetening terms of their private student loans because those are the only types of student loans they can offer any more. In the past, student lenders earned healthy profits by issuing federally guaranteed student loans. That ended last year, when Congress adopted legislation eliminating the role of private lenders in the federal student loan program. All federal student loans are now issued through the Department of Education's Direct Loan program.
But while some private loan rates look appealing, you should never sign up for one until you've maxed out on federal student loans. And even then, you should scrutinize the terms of the loan contract before you borrow. Here's why:
.Your interest rate could rise. Almost all private student loans have variable interest rates that are tied to an index, such as the prime rate or the London Interbank Offered Rate (LIBOR) index. That means there's a good chance that the rate you start with will increase before you repay the loan - and if interest rates soar, it could rise significantly.
.You'll probably need a co-signer. Unless you have excellent credit, you'll need a co-signer to get the lowest interest rates on private loans. This is a serious responsibility: If the borrower can't pay, the co-signer is on the hook for the debt. Federal student loans are available for all full-time students, regardless of credit history.
.Private student loans have less-flexible repayment terms than federal student loans. If you lose your job while you're repaying a federal student loan, the government is required to allow you to temporarily suspend payments on the loan. Some private lenders offer forbearance or interest-only payments to borrowers who are experiencing economic hardship, but that's voluntary, says Deanne Loonin, director of the National Consumer Law Center's Student Loan Borrower Assistance project. "You get whatever the lender chooses to give you," she says. "There's no law that requires certain kinds of relief."
.A late payment could cause you a world of hurt. Most federal student loans aren't considered in default until the borrower has missed payments for nine months. The default trigger for private loans varies, depending on the contract, but some lenders will declare you in default after one missed payment, Loonin says.
If you default on a student loan, lots of bad things will happen: The entire amount will come due, you'll probably start getting calls from collection agencies, and your credit score will be ruined.
Even if a late payment doesn't trigger default, your lender could boost your interest rate, according to Student Lending Analytics, a research firm.
.Severe disability may not release you from your loan obligation. Borrowers with federal student loans who become severely disabled have the right to apply to have their loans permanently discharged. Some private lenders will discharge loans for borrowers who are disabled, but they're not required by law to do so.
.Death may not end your loan obligation, either. Federal student loans are typically discharged if the borrower dies before the loan is paid off. Co-signers of private loans, however, could be held responsible for payments, depending on the terms of the contract, says Lauren Asher, president of the Institute for College Access & Success.
That's what happened to the family of Christopher Bryski, a Rutgers college student who suffered a traumatic brain injury in 2004. When he died two years later, his father, Joseph Bryski, was held liable for $44,500 in private student loans.