Choosing the right student loan

Everyone understands the value of an education, but that doesn’t make the price tag any easier to swallow. The average cost of tuition at a public university is already over $5,000 a year and it’s rising about twice as fast as inflation. Books and living expenses, especially if you’re attending a college out of town, can easily double that. That’s why more than half of all college students in the U.S. rely on student loans.

There are many types of student loans available from the government and private lenders. Here’s an overview to help you determine which one is right for you:

Government loans
Most federal government loans are administered by one of two programs. Under the Direct Loan program, you receive the money from the U.S. Department of Education. In the Federal Family Education Loan (FFEL) program, the goverment teams up with participating banks, credit unions and other lenders. The government secures the loan, so you receive a favorable interest rate.

There are three major types of federal student loans:

Stafford Loans are granted to undergraduate or graduate students enrolled at least half-time at an accredited school. These carry a fixed interest rate and you have between 10 and 25 years to pay back the loan. If you have financial need, you can apply for a subsidized Stafford loan, in which the government pays the interest while you’re attending school and for six months after you leave.

PLUS loans are available to Parents who choose to take financial responsibility for their children’s education. (The acronym stands for Parent Loan for Undergraduate Students.) The interest rates are higher than with Stafford loans but parents can apply for the full cost of attendance, less any other financial aid received. There is no subsidy available for PLUS loans, so the parent must pay all the interest that accrues even while the student is attending school.

Federal Perkins loans are in a separate category from FFEL and Direct Loans and are designed for students with exceptional financial need. The money comes directly from the particular school attended, and must be paid back over 10 years or less. If you qualify, Perkins loans offer a very attractive interest rate, there are no fees and you do not have to begin repaying the loan until nine months after graduating.

For information on how to apply for federal loans, read our article: Applying for federal student loans

Private loans
If you do not qualify for a Perkins or subsidized Stafford loan, or if your parents are turned down for a PLUS loan, you still have options. Private lenders offer many loans that can help you with your college education. Most carry higher rates than government loans, but lower than other types of consumer borrowing.

Borrowing money from a bank or credit union may be more expensive than a federal loan, but there are some advantages. First, private loans may be easier to qualify for. Also, the amounts available from federal programs vary widely, but they all have ceilings. At the time of writing, a Perkins loan for an undergraduate is no more than $4,000 a year. A Stafford loan for a first-year dependent student (in general, one who lives with a parent) is just $3,500. Private lenders may approve you for considerably more -- often the full cost of education minus any grants or other aid you receive. Many students use private loans to top off what they receive from the government.

Parents who want to borrow for their children’s education may find more flexibility with loans backed by the equity in their home. A home equity line of credit, for example, generally offers a competitive interest rate (often lower than that of a PLUS loan) and allows you to make a draw only when you need the money. In addition, the interest on the loan may be tax deductible. (Consult a tax advisor about your situation).

Your school’s financial aid office may offer you a list of the school’s preferred lenders. Ask your financial aid officer to explain the features of the loans each of these lenders offer, and don’t limit yourself to the banks on the list. It’s wise to shop around to see if you can find a better rate and terms.

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