Thanks to the Government, Student Loans Are a Better Bargain

The days of cheap and easy education loans are gone. But most students can still borrow enough to get through their local public colleges without mortgaging their futures.

In fact, there's a silver lining to the credit crunch. The government is allowing all undergraduates to borrow more money from one of the best federal loan programs, and it has cut the rate on some loans to low-income students. What's more, the turmoil has attracted upstart companies that are helping students make alternative arrangements, such as borrowing from rich relatives. So by shopping around, you should be able to find lenders that offer at least a small discount on modest-size loans.

"Even if you only save 1 percent, on a $5,500 loan, that saves you $55," notes Tim Ranzetta, founder of Student Lending Analytics, a Silicon Valley start-up that searches out the cheapest student loans for colleges.

The first step is the FAFSA form. It's complicated, but it's worth the hassle since it qualifies all students for a Stafford loan. Those with low incomes may also get better deals and, best of all, some free money for college.

This fall, Staffords will charge a maximum rate of 6.8 percent, plus 2 percent in upfront fees (true maximum APR: 7.4 percent). Thanks to emergency legislation passed in the spring, entering freshmen will be able to borrow up to $5,500, sophomores $6,500, and upperclassmen $7,500 through the Stafford program.

Shop locally. The credit crunch and last year's scandals over kickbacks to financial aid offices have sparked a move by some colleges to require all students to take their Stafford loans directly from the federal government, which offers few discounts. But most schools still allow students to shop. Some of the cheapest loans are offered by state-run agencies and nonprofits; the Rhode Island Student Loan Authority, for example, will waive all Stafford fees and knock half a percentage point off loans paid automatically. Most agencies offer deals only to local students; you can check availability at EFC.org. Another search tool, developed by SimpleTuition in partnership with U.S. News, lists some of the cheapest state and national loans. And many school financial aid offices maintain a list of agencies eager to lend to students.

Low-income students can often get better deals. They can qualify for "subsidized" Staffords, which charge no interest while a student is in school and 6 percent after that. Many schools also offer Perkins loans, which charge just 5 percent. Experts recommend that most students stick to the federal programs. They are cheap and can be at least partially forgiven for students who go into low-paying public service jobs. In addition, the limits prevent students from graduating with a crushing debt load.

Students who need to borrow more have little choice these days but to turn to relatives or friends, since almost all other lenders require a good credit history. Parents who don't have bad credit can borrow the student's full cost of attendance (less financial aid) through the federal PLUS program, which charges a maximum of 8.5 percent a year, plus 4 points (true maximum APR: 9.4 percent). If a parent is rejected for a PLUS loan because of credit problems, a student can borrow as much as $5,000 a year more through the Stafford program.

The end of the housing boom has made home equity lines of credit harder to get this year, but parents can cosign private loans ("signature" or "alternative" loans) for students. These are simple business transactions, and they can be risky. For borrowers with top credit scores, for example, Discover is offering rates pegged to prime, which was about 4 percent this summer. But it can charge twice that rate to those with less-than-perfect credit. In addition, cosigners are responsible for the debt if the student ever defaults.

One possibility is a range of intriguing alternatives from firms such as Virgin Money and Fynanz. Students who find someone willing to lend them money can pay as little as $199 to have Virgin Money do all the paperwork, turning an informal agreement into a real loan that will be treated just like a bank's (though typically at a lower interest rate). Fynanz tries to line up investors willing to lend (but who typically demand a cosigner) to students they don't know. The companies are so new they don't have much of a track record with education loans yet. But the first loans ever made were, of course, from one individual to another. As the Internet links students who need cash with investors, the future of lending may start to resemble the distant past.