The credit crunch and debacle on Wall Street have wiped out those easy-peasy $40,000 college loans that used to be all over late-night TV. And the feds are considering a dramatic consolidation of the educational lending industry that could reduce options still further. But no matter what happens in Washington or on Wall Street this year or next, most students will still be able to borrow enough to cover the bulk of tuition at their local public university at a reasonable cost from the feds.
One of the most surprising results of the turmoil in the lending markets is how students' loan options have diverged from parents'. Here are the key things both should bear in mind:
Deals for students. Students should always start with the feds. The first step: filling out the FAFSA form, the Free Application for Federal Student Aid.
All full-time students who complete a FAFSA and a federal loan agreement provided by their school's financial aid office can borrow at least $5,500 a year through the Stafford student loan program. Students who are at least 24 or whose parents have bad credit can get Stafford loans of up to $9,500 to $12,500, depending on their year. This fall, Staffords will charge no more than 6.8 percent a year in interest plus a 1.5 percent upfront fee, for an average annual percentage rate of 7.1 percent.
Low-income students generally qualify for better deals. Some will receive federal Perkins loans, which charge no interest while students are in school and just 5 percent after they leave. And most needy students will receive "subsidized" Stafford loans, which for the academic year starting this September will charge no interest while students are in school and 5.6 percent after they leave.
Need more? Uh-oh! Dropping out of college is usually far more expensive, in the long run, than sticking it out and graduating to qualify for better jobs, so it can pay to borrow a little extra to make it to commencement. The problem is that students who need more than the government will lend have few good choices, says Greg McBride, a senior financial analyst for Bankrate.com. Here are some possibilities:
Charities and colleges. A few charities, such as Maryland's Central Scholarship Bureau and the Scholarship Foundation of St. Louis, award interest-free loans to a handful of needy students each year. And some colleges, including the University of Minnesota-Twin Cities, are trying to un-crunch credit by making loans themselves. But beware: Lauren Asher, acting president of the Institute for College Access and Success, warns that while many of these are good deals, students shouldn't automatically accept every loan they are offered.
Alternative loans. Banks and other lenders have gotten so picky recently that they've been making only private (or "signature") education loans, often at high variable rates, and only to U.S. citizens with good credit scores (typically those with FICO scores of at least 700). That means most students need at least one employed cosigner to promise to repay their private loans. It also means private loan costs will rise when interest rates bounce back up. But borrowers who can convince lenders that they are responsible and capable of repaying, such as Sarah Kelly of New York City, have been able to find cheap alternative loans. After suffering with $50,000 in private law school loans charging 7 percent a year, the recent New York Law School graduate and her parents agreed to try out a Student Payback contract offered by Virgin Money. Her parents paid off her expensive private loans. In return, Virgin Money withdraws a monthly payment from Sarah's checking account to pay back her parents at a lower rate.
Options for parents. Parents, unfortunately, have to do more legwork, as Gary Krist of Bethesda, Md., the father of a rising Northwestern University freshman, discovered. He was shocked this spring when he saw how several colleges had packaged expensive parent loans into his daughter's financial aid offers. But at least it was motivating: Over the next month or so, he and his wife spent about 20 hours calling up alternative lenders and scouring the Web for better deals.
Federal loans are no bargain. While students can borrow comparatively small amounts of money cheaply from the feds, parents are offered bigger but more expensive loans. The federally backed parent PLUS loan can cover the student's entire cost of college (less any other financial aid). But PLUS loans can cost as much as 8.5 percent a year plus a fee of 4 percent of the loan amount, for a total annual percentage rate of as much as 9.4 percent. Shoppers can find discounts, however. Those who borrow directly from the federal government and make automatic electronic payments are charged just 7.65 percent in interest. (After fees, the APR totals 8.55 percent.) And the eligibility criteria are comparatively forgiving, even for parents who are a little behind on their mortgages.
Nonprofits and colleges. Traci Smith of Highland, Calif., was heartbroken when she was 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. When Traci called the school's aid office, however, the officer told her Redlands had joined a growing number of colleges making loans to recession-strapped parents. Redlands lent the Smiths the last $3,200 (at 8.5 percent) they needed to pay their bill. A few nonprofits, such as the Rhode Island Student Loan Authority, are offering local parents alternative loans with fixed rates below 8 percent.
Banks and private lenders. Many parents are enticed by sub-4 percent private loan interest rates advertised by banks and firms such as Sallie Mae. But Tim Ranzetta, president of Student Lending Analytics, recommends doing some homework: This summer, parents with good but not great credit were often looking at 12 percent plus. In addition, Ranzetta warns those rates are variable.
Luckily, several Web tools have emerged to help parents and students find and compare loans. Ranzetta has rated the most popular private loans based on their interest rates and consumer-friendly terms at studentlendinganalytics.com, and SimpleTuition.com lets shoppers compare a range of rates offered by several lenders.
Home equity loans. Troubles in the housing market have given parents with good credit and plenty of equity a chance to take cash out of their homes at near-record-low rates. After Krist shopped around, he realized he couldn't beat a home equity line of credit for a floating rate that started out at about 4 percent. And Krist says he doesn't mind taking on the debt for his daughter. After all, his parents borrowed so that he, too, could graduate debt free.
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