The Loan Without the Regret

For students who must borrow, federal reform and a brightening economy are silver linings.


Lauren Hoover, a 2009 graduate of Indiana University, can afford to whittle down her loan ahead of schedule.

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Lauren Hoover made a classic freshman mistake. When she maxed out her low-cost federal Stafford loan and ran out of scholarship money but still hadn't paid all her first-year bills at Indiana University-Bloomington, she contacted only one lender. It gave her and her parents a private loan at 7.4 percent to bridge the gap. 

It wasn't until long after the papers were signed that her mom noticed her employee credit union offered private student loans with lower interest rates. The loan from the Eli Lilly Federal Credit Union brought Hoover's cost of borrowing for her sophomore year to less than 4 percent. Hoover, who graduated early with a degree in exercise science in December 2009, is now reaping the benefits of the switch.

The lower interest rate cut her monthly payments by about $50 and will probably reduce the total amount she will pay in interest over the years by more than $6,000. Figuring out the best loan option "is so incredibly confusing," Hoover says. But the savings are so significant "it is worth the legwork." 

As scholarships lag behind skyrocketing tuition, a growing number of students have no choice but to borrow to pay their college bills. Luckily, incremental improvements in the economy (like a loosening credit market), growing competition among private lenders, and federal reforms are making student loans cheaper, simpler to get, and easier to repay. 

For fall 2010, federal student loans offer undergrads the chance to borrow at rates as low as 4.5 percent, affordable monthly payments, and a chance at getting some of the debt forgiven. Those who need to borrow more than the government's maximums and who have good credit ratings (or cosigners with good credit) can apply to private banks and credit unions, many of which have been cutting their interest rates on alternative student loans. But even the private companies advertising alternative tuition loans are now required to advise students to start with the federal loans, which offer many advantages. Several developments promise to make student loans of all types even more attractive. They'll be: 

Cheaper. Nearly all undergraduates can borrow at least $5,500 a year (older, low-income students as much as $18,000) at fixed annual percentage rates that in the summer of 2010 had fallen to a range of 4.5 percent to 6.8 percent. Unlike private lenders such as Sallie Mae, the federal Stafford program will lend to students without requiring a payment guarantee from an adult with good credit.

To qualify for the Stafford loan program, students must be U.S. citizens, attend school at least half time, and not be in default on other federal student loans. Some low-income students can also borrow from the federal Perkins program. The interest that students pay on federal student loans and the amount they can borrow depends on age, year in school, income, and college. People with lower incomes generally get lower interest rates. Older students can generally borrow more. And there's more good news on the horizon: For the 2011-2012 academic year, the government will slash the interest rate on Stafford loans made to low-income students to just 3.4 percent.

Those who need to borrow more than the federal maximum also have newly attractive options. Credit unions and Web entrepreneurs are rushing in to fill the vacuum created when the credit crunch wiped out many traditional student lenders. The state-owned Bank of North Dakota, for example, offers students in or from the state a variable rate that rested at 2.04 percent during the summer. By mid-2010, the easing of the credit crunch and new competition had pushed other lenders, such as Sallie Mae and the credit unions belonging to Credit Union Student Loans (www.cuStudentLoans.org), to cut their lowest variable-rate loans to about 3 percent for students with excellent credit. Of course, loans with variable rates get more expensive when interest rates rise. 

Simpler to get. The Department of Education has simplified the process of getting a federal student loan. While students still must complete a Free Application for Federal Student Aid, the government has streamlined the online version of the form. To apply for a federal loan, students need only make sure the FAFSA is filled out entirely, including the box asking about their interest in loans, and tell their college they would like a loan. They no longer need—or have the opportunity—to shop for a bank to make a federally backed loan. The law now requires colleges to funnel all federal loan applications directly to the government. "The process will be easier" for students, says Sharon Hassan, director of financial aid for Goucher College in Baltimore. 

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