ARCHIVE:: MARCH 2002 :: YOUR MONEY

College Loans Demystified
Staffords Are for Students, PLUS for Parents

SMARTMONEY.COM

Financial aid is quickly becoming a synonym for student loans. These days, close to half the students in four-year colleges take out loans -- and it's a rare student who isn't confounded by the process.

This brief guide should help to clear up some of the confusion about government-sponsored loan programs.

The two most common government-sponsored education loans are called Stafford loans and PLUS loans.

Stafford Loans are those that students borrow themselves. The interest rate is capped at 8.25%, but varies below that ceiling annually. Students who take out Stafford loans are limited to $2,625 the first year, $3,500 the second and $5,500 the third and fourth (and fifth, if need be) and $8,500 per year for graduate school. Eligible borrowers can get part or all of their loans subsidized -- meaning that the government pays the interest while you're in school. You don't start paying off the loan until six months after graduation.

PLUS loans are those the government sponsors for parents with good credit histories. The rates are capped at 9% but vary below that ceiling annually. There's no specific limit on PLUS borrowing, but your parents have to start repaying the loan immediately, principal and interest, while you're still in school.

There's more to getting a Stafford or PLUS loan than simply filling out the forms, however. Before you borrow, be sure to review these three important points:

Who Should Borrow, You or Your Parents?

It used to be the student had to max out on Stafford loans before their parents could take on a PLUS. Not anymore. Starting a few years ago, parents became eligible to borrow the entire cost of college, whether or not their children took advantage of the Stafford loan program.

But even if your parents plan on repaying the loans themselves, you should borrow first. Students get the lower rate on Stafford loans and can defer the interest payments.

Moreover, students are more likely to benefit from the deductibility of student loan interest, because their incomes are less likely to exceed the federal eligibility cap. As of this year, single individuals who earn less than $65,000 and couples earning less than $130,000 can deduct at least part of their student-loan interest charges up to a maximum of $2,500.

Finally, some employers agree to help new hires pay off their educational debts, so there's a chance that you may get bailed out at work after graduation.

Choosing a Lender

If your college participates in the direct-student-loan program, then the choice is made -- you should get your loan through the college. But if you're looking for a private lender, there can be vast differences among the various institutions that offer student loans. Be sure to ask any lender you're considering the following questions:

How frequently do you calculate interest on the loan? The more often interest is calculated, the bigger your debt will be when it's time to pay up. For instance, on a $14,000 unsubsidized Stafford, if interest is calculated quarterly over four years instead of just once, at the time repayment starts, students graduate owing hundreds more.

Do you offer repayment rewards? Banks don't like to chase defaulters, so some are offering incentives for on-time payments. The 1,200 lenders affiliated with Sallie Mae, for instance, will reduce your rate by 0.25 percentage point if you authorize automatic monthly deductions from a bank account. Make your first 24 payments on time and your lender will refund the 3% origination fee you paid your bank when you took out your loan, minus $250. If your first 48 payments are on time, you'll get a two-percentage-point rate reduction on the balance of your loan. Nellie Mae, a New England lending agency, gives you a 0.25% reduction if you authorize automatic withdrawal or reduces the interest rate by 2% if your first 48 payments are on time. Ask your lender if it is involved in any of these programs or offers any of its own incentives.

Do you have a consolidation plan? If you know you'll be taking out several loans, make sure at least one of your lenders has an attractive consolidation plan. Sallie Mae, for instance, offers a quarter-percent discount if you opt for direct repayment and lowers your rate by 1% after you make the first 48 payments on time.

Are there state-run incentives? Many states now offer subsidies on student and parent loans. Some lenders in Maine, for instance, offer one percentage point off on Stafford and PLUS loans. Check with both your home state and the state where your school is located.

Before You Pay Up

You want a lender that has a variety of repayment options. The most common repayment plan is a fixed amount per month for 10 years. But some lenders also offer graduated plans that assume your income will rise the longer you are out of school. This plan allows you to increase your monthly payment in two to three stages. And, with some lenders, students can consolidate their loans to increase the repayment time from 10 to, say, 20 years at a slightly higher interest rate.

All lenders will let you defer payments if you decide to go back to school or take up volunteer work. Unemployment, internships and fellowships may also entitle you to a deferral. And all lenders are required to allow up to 24 months of hardship "forbearance."