Knowing your student loan options; Federal Loans vs. Private Loans
Jose Espada Jun 22, 2011
Although I love Sandra Block (who covers personal finance for USA Today) dearly, I can’t help but be a little disappointed with her sloppy reporting in her recent edition of “Your Money” in the June 19, 2011 Sunday STAR. Why is that? Well, when you leave out key pieces of information, it makes it difficult for people to be fully informed and people like me have to clean up her sloppiness.
She mentioned students who qualify for Federal Subsidized Stafford Loans will be paying interest of 3.4% beginning July 1, 2011. This is true, but only for undergraduate students and only until June 30, 2012, when the interest goes back up to 6.8% on July 1, 2012. The reason the loan is subsidized is because the federal government pays the interest on that loan while the student is in school and for the 6-month grace period once the student separates or graduates from school. Recently, as part of Congress’s discussions and efforts to cut the budget, there have been overtures to take the subsidy away from graduate and professional students. As of last year, all Federal Stafford Loans are through the U.S Department of Education Direct Loan Program cutting out lenders and servicers from the process.
Ms. Block makes reference to private loans and for the most part what she reports is good. She failed to mention that private loans are not the only option for eligible domestic graduate and professional students. Given the many federal government protections, the Federal Graduate PLUS Loan is the more desired choice for graduate and professional students. The Grad PLUS Loan is the equivalent of a private loan through the federal government, albeit a fixed interest rate of 7.9%. The Grad PLUS Loan does not have the interest rate volatility of private loans that are based for the most part on the London Interbank Offered Rate (LIBOR) index. Some are still based on the prime rate index. So, with private loans there is the real chance that your interest rate will increase before you begin repayment. And, if we hit another economic downturn, the interest rate on private loans can go through the roof.
Lastly, private loans have less-flexible repayment options. I have had medical students who have borrowed a private loan in undergrad and end up having to begin repayment while in medical school, which proves to be a major hardship. This is why I advocate for students to exhaust all federal loan avenues first before jumping on the private loan bandwagon. A few missed payments on a private loan could prove to be extremely harmful to your credit score and also trigger the calls from collection agencies. Federal loans have ways to assist students with delaying repayment by using forbearances or provide repayment plans that may fit the student’s budget.
Federal loans have a provision to permanently discharge or cancel loans in the event of death or total permanent disability. This is not the case with private loans and some lenders may consider doing something, but are not required by law to do anything. In many cases, it would be a good idea to carry insurance against the debt to insure that you do not pass on the debt to your estate. Co-signers may be under obligation to pay the debt in the case of the borrower’s death or total permanent disability. This is another reason why securing a co-signer may be difficult to attain.
Ms. Block did not go far enough with her statement regarding a co-signer. Although, in some sectors of the private student loan industry having a co-signer is a good thing and can garner a better interest rate, the primary reason for a co-signer in a student loan environment is generally to get a student qualified. Students with bad credit issues will need to seek a co-signer who has a good credit situation and is willing to take on the responsibility for the loan in the event the student cannot repay the loan.
She states that federal student loans are available to all full-time students, but here once again failed to mention that half-time students are also eligible and additionally, must be in a degree-seeking program to be eligible. Just simply going to school and taking courses does not automatically make you eligible for student loans.
In some cases, for fourth year medical students, private loans are the only way to finance relocating from medical school to a residency position. These private loans do not go through the school and the application and receipt of these funds are directly between the students the lender that offers it. Fortunately, residency interview expenses can now be accounted for in the financial aid budget due to a recent re-interpretation of the federal guidelines by the U.S. Department of Education. With this new opportunity to account for these expenses, fourth year medical students will be able to utilize federal loan funds instead of private loan options. This is a good thing since you cannot include a private loan into a federal consolidation loan and a private loan does not qualify for the Income Based Repayment or the Public Service Loan Forgiveness Program.