Loans-The Good, the Bad, and The Ugly

In many cases, your financial aid package will contain grants, scholarships, and loans. As we've talked about before, grants and scholarships are free money--money that does not have to be paid back. Loans, however, do have to be paid back.

What types of loans might you see on your offer letter?

Let's start with the Federal Loans. The main loan types are:

• Perkins--based on need, these loans are provided at a fixed rate of 5%
• Stafford Subsidized--based on need, these loans are currently at 6%, fixed, and interest is paid by the government while the student is in school.
• Stafford Unsubsidized--not based on need, these loans are currently at 6%, fixed, but interest accrues while the student is in college (you can pay the interest monthly or it will be capitalized and added to the principal at graduation).
• Federal Direct Loans--these are the same as the Stafford, but come directly from the government instead of through a lender.
  
• PLUS loans--not based on need, parents can borrow up to the total cost of education. Current rates are at 8.5%. They are usually expected to be paid back starting 60 days from disbursement; however, there are options to defer payments until after graduation (interest continues to accrue).

Interest rates are set each year in July--so, for example, July 2009, the interest rate will be set for the 2010-2011 year. Hence, you may end up with loans at different rates each year. That's where consolidation comes in. All Federal loans are eligible to be consolidated, which means that they repackage the entire amount at new interest rate that's usually a little bit less than the average rate for your four years (plus the current year).

Loans start getting repaid 6 months after graduation.

In addition to the Federal loans, many banks offer gap loans, which are private loans for education. The interest rates on these are variable (quarterly). The interest rates for gap loans are widely varying (currently 5%-12%) and they're based on credit worthiness. So, if parents have a good credit score and are willing to co-sign, then they may pay similar rates to the subsidized Stafford. However, a student applying for a gap loan without parents cosigning (unless they have their own established and high credit rating) is likely to be paying double digit interest. Because of this variability, be wary of gap loans, though they certainly can have their place. Gap loans CANNOT be consolidated, since they are private, so take that into consideration as well when deciding what loans are best for you.

Shop around for your loans. Currently (and the Obama administration may force changes to this), Stafford loans are offered by a wide variety of banks, from Sallie Mae to Citibank to Wells Fargo. To get your business, they compete with each other in the terms of the loans, which means that you should shop for the best deal. The variables most often offered pertain to interest rate cuts for

• On time payments--you can get reductions of .5 to 1 percent for making payments on time--usually after 24-48 payments. So, look for the best combination (highest reduction on the least number of months).
  

• Automatic payments--most banks will reduce interest rates by .25 to .5 percent if you sign up for automatic payments.
  

You can get a significant reduction this way.

Some of these interest rate cuts will also apply to gap loans.

Contact Diana at College Mentors if you have questions or want help deciphering the maze of your financial aid offers.