4 Ways to Find Cheap Student Loans

The Wall Street collapse and the national recession have wiped out those cheap and easy $40,000 student loans that were advertised on late-night TV last year and have raised the real costs of many remaining education loans But the financial storms also have created a couple of surprising silver linings. Most students can still get enough reasonably priced loans to cover the bulk of tuition at local public universities. And some students and parents actually will get better deals than ever before. The government is cutting interest rates on the loans it makes to the neediest students, and lucky parents who still have good credit and lots of home equity are able to pull college cash out of their homes at record-low interest rates. What's more, a growing number of colleges are trying to fill the loan vacuum by offering students comparatively low-cost supplemental loans.

Finding bargain educational loans can take a little work, though, discovered Gary Krist, the father of a Bethesda, Md., high school senior. He was shocked when he saw the expensive loans packaged into his daughter's financial aid offers this spring. After fees, some federal parent loans, such as the ones Krist originally was offered, will cost more than 9 percent a year. "I was so trusting that they would give us a good deal. It was disillusioning," Krist says.

So he started shopping around for cheaper alternatives. Krist, who bought his home in the Washington suburbs long before the real estate bubble started, was able to get a home equity line of credit starting at about 4 percent. Since that interest will be tax deductible, his real cost will be even lower. Krist, an author who wrote a novel about financial bubbles, is betting economic troubles will keep interest rates and his payments low for months if not years. "Just because a loan offer comes with the imprimatur of the government or a respectable institution of higher education doesn't mean you can't get a better deal elsewhere," Krist says.

Of course, students are better off if they can pay for college without borrowing at all, perhaps by choosing lower-cost schools or raising lots of free grant and scholarship money, for example. But the harsh reality is that while underclassmen can attend community college for, typically, about $2,500 a year in tuition, upperclassmen typically have to pay an average of about $7,000 a year for tuition, plus an additional $1,000 for books. Living away from home typically adds $10,000 or so in housing, travel, and food expenses. And there simply isn't enough scholarship money to help every needy student. So loans are often the only way to pay for a degree.

Nevertheless, the payoff of college is typically high enough to warrant at least a few thousand dollars in debt each school year, experts say. And a few smart moves now can make those loans especially affordable.

Start with the feds: The single biggest and best source of student loans for fall 2009 is the federal government, says Edie Irons, spokesperson for the Project on Student Debt. The first step to getting federal loans: Fill out the Free Application for Federal Student Aid.

All full-time students who complete a FAFSA can borrow at least $5,500 a year through the Stafford student loan program. Students who are at least 24 years old or whose parents have bad credit can get Stafford loans of up to $9,500 to $12,500, depending on their year in college. Staffords for the fall of 2009 will charge no more than 6.8 percent a year in interest plus a 1.5 percent upfront fee, for an average annual rate of 7.1 percent. Students who qualify as needy may be able to get Staffords that charge no interest at all while they are in school and just 5.6 percent after graduation.

About two thirds of colleges allow students to shop around for the best Stafford deal instead of funneling loan applications directly to the federal government. The credit crunch has eliminated most of the good deals common in previous years. But a few lenders are still offering small sweeteners. Many nonprofit lenders, such as the College Foundation of North Carolina, and some for-profit companies, such as Discover, waive most or all of the upfront fees and knock a fraction off the annual rate for automatic payments. Those kinds of discounts typically save borrowers several hundred dollars over the life of the loan.

At an effective rate of 7.1 percent, when the prime rate is just above 3 percent, Staffords might look expensive. But they offer many unique benefits, such as new forgiveness programs for public servants and an income-based repayment plan that will allow debtors to cap their payments below 15 percent of their income.

Parents can tap education loans that cover the student's entire cost of college (less any other financial aid) through the federal PLUS program. PLUS loans aren't cheap, unfortunately. They can cost as much as 8.5 percent a year plus a fee of 4 percent of the loan amount, for a total annual rate of as much as 9.4 percent. But shopping around can reap a few discounts. Those who borrow directly from the federal government and make automatic electronic payments are charged just 7.65 percent in interest, for example. (After fees, the APR totals 8.55 percent.) And there are other benefits: While PLUS applications do require a credit check, the standard is comparatively forgiving, even OK'ing parents who are a little behind on their mortgages. Also, PLUS loans allow parents to defer payments until the student is out of school (though the interest does keep building up.)

Ask your school: Traci Smith was heartbroken last summer when she got turned down for a PLUS loan, and it looked as if she wouldn't be able to send her daughter, Rhea, to the University of Redlands in Southern California. When Traci called to alert the school's aid office, however, the officer told her the school had just joined a growing number of colleges making loans to recession-strapped parents like her. Redlands lent the Smiths the last $3,200 they needed to pay their bill. Now, Rhea is hard at work studying to become a music teacher. "Without that loan, I would have had to change my aims and profession" since her local community college doesn't have many music education courses, says Rhea. "That loan saved me."

Many schools also offer Perkins loans, which are federally backed loans for needy students that charge no interest while students are in school and just 5 percent after they leave. Unfortunately, colleges have a limited amount of Perkins money and so can't always award these loans to everyone who qualifies.

While many school loans are good deals, Lauren Asher, acting president of the Institute for College Access and Success, warns that students shouldn't automatically accept all loans they are offered. "Just because the loan has the school's name on it doesn't mean it is the best you can do," she says.

Alternatives: Some charities and new Web companies are giving students a chance to borrow at no or low interest.

After suffering with $50,000 in private law school loans charging 7 percent a year, recent New York Law School graduate Sarah Kelly found a way to save herself thousands of dollars. She and her parents signed a Student Payback contract offered by Virgin Money. Her parents paid off her expensive private loans. In return, Virgin Money withdraws from Sarah's checking account a monthly payment that will eventually pay back her parents everything plus minimal interest. The lower interest cuts the total she'll end up paying by thousands of dollars. Virgin Money makes the transaction easy and unemotional by turning her family debt into the same kind of payment as a utility bill. "I don't have to think about it," Kelly says. Other companies, such as GreenNote, offer would-be borrowers the ability to send out electronic appeals for private student loans.

Private lenders: The credit crunch has wiped out most of the private, alternative (also sometimes called "signature") educational loans. But students who can find a U.S. citizen with good credit (a FICO score of at least 700 is generally required) to guarantee payments can usually find a bank willing to lend them at least a little money. Financial experts suggest private loans be considered only as a last-ditch alternative, however, as they can be onerous. "It used to be that anyone with a pulse could get a loan," says Greg McBride, an analyst for Bankrate.com. "Now you've got to jump through more hoops than a circus act."

Some private loans, such as Sallie Mae's new "Smart Option," require payments to start almost immediately—while the student is in school.

Private loans can also be expensive. A few nonprofits, such as the Rhode Island Student Loan Authority, are offering fixed rates below 8 percent. But most for-profit lenders were offering only variable rates in late spring 2009. Their rates ranged from a tick below prime (which was about 3 percent) to 14 percentage points above the London interbank rate (Libor), which was hovering around 1 percent. Those with good credit will very likely be offered cheap-sounding rates as low as 4 percent, but "the rates will only go up from here," warns Tim Ranzetta, president of Student Lending Analytics. "When the economy gets back on its feet, the rates could be 3 to 4 percent higher than they are today," which could ratchet payments up by hundreds of dollars a year, Ranzetta says.

Ranzetta warns that shopping for an affordable private loan smartly requires a lot of work in a short time. Lenders typically don't reveal the rate they'll charge you until you've completed a lengthy application, so smart shoppers have to fill out several applications. Credit rating agencies will allow borrowers only 30 days of shopping for a loan before dinging credit scores, he says. And borrowers concerned about their jobs would be wise to read the fine print in each loan document about the fees for deferring payments if they get into financial trouble, Ranzetta advises. Bankruptcy courts generally refuse to discharge educational debts (unlike, say, credit card debts), so borrowers have little choice but to pay all interest and fees on educational debts.

As troublesome and expensive as private loans are, however, they are not the most expensive way to raise cash for college, says Bankrate's McBride. Many credit cards actually charge more than private loans. And cashing out a retirement account can be even more expensive because of tax penalties.

If it's the only way to make it through college, borrowing a few thousand dollars a year at a reasonable interest rate is generally rated a good investment. After all, the typical college graduate grossed almost $4,000 a month last year. Those who didn't go to college earned about $2,400. That difference of $1,600 a month won't make up for really big debts, though, and isn't guaranteed. Some college graduates, especially those entering the job market during the current recession, might have to get by on less and thus won't have much extra to divert to loan payments. 

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