Crash course on loans: For college students and parents, new ways to finance a diploma

Crash course on loans: For college students and parents, new ways to finance a diploma

Crash course on loans: For college students and parents, new ways to finance a diploma

July 1 has always been a big day when it comes to federal student loans. Not only is it the time when interest rates on variable-rate loans readjust, but last year it brought the introduction of the income-based repayment option that's been a boon to borrowers with large loans and small paychecks.

This year, another change is coming: As part of the new Health Care and Education Reconciliation Act, federal student loans will no longer be offered by private lenders. Instead, they'll be issued by the Department of Education's Direct Loan Program.

But that means we'll likely see more private lenders return to the private student loan market after stepping away during the credit crisis.

"A number of banks, credit unions - basically any institutions that have customer deposits - will be returning, in part to replace the loss of federal education loans," said Mark Kantrowitz, publisher of FinAid.org. "These lenders were previously making federal loans. Now that those loans are all going direct, if [those lenders] want to stay in this business, they need to create new products."

With new resources at students' disposal, how can they and their parents know where to start when it comes to borrowing money for college? Here's a guide.

FEDERAL COMES FIRST

This is a hard and fast rule: Before you even think about taking out private loans, max out your federal loan options.

This sounds like a no-brainer, but it isn't: Last year, the Project on Student Debt found that during the 2007-08 school year, 64% of private loan borrowers could have taken more in federal Stafford loans. Not only do federal Stafford loans carry lower interest rates - fixed at 6.8% if taken out after July 1, 2006, and variable, but capped at 8.25%, if taken out before - they have a wide range of repayment options. Private loans tend to have higher variable interest rates based on your credit score, set repayment periods and less flexibility.

Once federal student loan options are maxed out, parents should consider a PLUS loan, said Kevin Walker, co-founder of SimpleTuition. "This federal parent loan is an alternative to using a private student loan. A lot of parents feel they've done a lot already and don't want to borrow more, but all things being equal, this is probably a cheaper means of getting money than a private loan." These loans come with a fixed rate of 7.9%.

If you're a parent, don't brush aside your retirement planning, but this could save a lot in interest. Remember: you're on the hook for repayment, not the student.

START CLOSE TO HOME

Deposit institutions are going to be the primary source of private loans, as Kantrowitz said, and your best bet is to start your search with the bank or credit union you already use. If that doesn't work, expand your search. Sites like SimpleTuition.com will help you review a range of lenders, and the recently established StudentChoice.org focuses on credit unions.

If you have a bad credit score or can't find a co-signer, a credit union may be your best bet. "If these private loans are available to students without a co-signer, they're more likely to be from a credit union than a big national lender," Walker said.

APPLES TO APPLES

Ignore advertised rates. "The bulk of borrowers get the worst rate and a small minority get the best, but people still focus on the best," Kantrowitz said.

Instead, look at the total cost of the loan, which combines the interest rate, fees and the length of the repayment period. All of these add up to what comes out of your pocket. Walker said he's seen repayment periods ranging from seven to 20 years - a longer period means lower monthly payments, but more interest over all. Comparing only monthly payments means you're missing a large piece of the puzzle.

CONSIDER A CO-SIGNER

I'm against co-signing, in general, but when it comes to private student loans, there's really no way around it. Credit standards remain as tight as ever. Lenders "may have a private loan program this year when they didn't have one last year, but it's still something that is only available to students and co-signers with relatively strong credit," Walker said.

However, by Kantrowitz's estimates, four out of five students won't have the score or income to make the grade alone.

Your Money columnist Jean Chatzky is financial editor of NBC's "Today" show, a contributor to "The Oprah Winfrey Show" and the author of seven books, including, "Money 911: Your Most Pressing Money Questions Answered, Your Money Emergencies Solved." Check out her blog and learn about her Debt Diet Online at jeanchatzky.com

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