Whether you've saved a little or a lot toward your children's education, you're probably worried about keeping up with college's escalating costs.
The price of education seems to outpace inflation every year, causing more students and parents to turn to loans to fill gaps in their savings. A recent study by the Institute for Higher Education Policy shows that more and more people have been turning to private loans to pay for college.
In any student's life, a private loan may turn out to be more advantageous than a federal student loan, but the pace of private lending has the Institute for Higher Education Policy worried. They fret that students may not fully understand the difference between federal and private loans, and some may end up making a poor choice.
Private college lending has been fueled by rising college costs and the fact that student aid has not totally kept pace. At a certain point, students can max out their eligibility for federal student loans, namely Stafford loans. Some students, however, do not maximize their Stafford loans before turning to private loans.
Parents also have access to federal loans in the form of PLUS loans. Few take advantage of the option, but the numbers have recently been growing.
What's the difference between federal and private loans? The two types come with different interest rates, fees, and eligibility requirements, among other features. In some cases, federal loans offer more flexibility if a student or parent later ends up in economic hardship. Here are some things to ponder when weighing your loan options:
- Federal loans require students to be enrolled at least half-time. Students who want to work full-time and attend school may need to look to private loans if they don't meet this half-time requirement.
- The interest rates for federal loans have been fixed at 6.8% for Stafford loans and 7.9% or 8.5% for PLUS loans (depending on how the loan is issued). Private education loans tend to be variable. Though they may start with a lower rate than a federal loan, they could increase depending on fluctuations in interest rates.
- Fees for federal loans may be lower than for those issued by private lenders. The institute's report says federal loan fees typically total 3% or 4% of the loan amount, while private loan fees may vary between 0% and 11%.
- With private loans, your fees and interest rates may vary according to your credit history. In fact, your eligibility for a loan may depend on your credit history. Not so with a student's federal loan, which can be a boon to anyone with a less-than-perfect credit report. Parents' eligibility for a federal loan does depend on credit history, but that will not affect their interest rate or fees.
- Unlike private loans, federal loans offer a repayment plan based on income, should you find that you can't make your scheduled loan payments. This is not an option you can get with a private loan. Federal loans also give borrowers the right to defer their loans based on economic hardship or unemployment for up to three years. You'll find less flexibility among private lenders, though some may offer forbearance for up to a year.
- In the event of a tragedy, such as some bankruptcy cases, disability, or death, federal loans may be discharged. Not so with private loans.
If you're a student or a parent looking toward loans to fill any gaps in your college payment plan, look beyond a private lender's introductory interest rate. Consider how much you can expect to pay after you've left school and whether you have enough flexibility in the program to ensure that you can make those payments.
Check out our College Savings Center for more help on how to make sure your children don't put you in the poorhouse when they head off to college. Also, you can get a copy of our Guide to Paying for School, written by Robert Brokamp, which will show you the way. Finally, Motley Fool Green Light can help you meet all your money goals, from paying for college to saving for retirement.