Student loan guide

Important changes

For those borrowing this academic year, rates on federal Stafford loans (described below) for undergraduates have fallen to 4.29% annually. Other recent changes, either as part of new legislation or because certain features were allowed to expire, include the following:

• Rates on future subsidized and unsubsidized Stafford loans will be set at 2.05 percentage points above the yield on the 10-year Treasury note, and capped at 8.25% for undergraduate students.
• Graduate students are no longer eligible for subsidized Stafford loans, and their rates for unsubsidized Stafford loans fell to 5.31% in 2016.
• Graduate students and parents of dependent children taking out federal PLUS loans will face stricter standards to qualify.
• Interest rates for parents and grad students taking out PLUS loans will fall to 6.31%, down from 6.84% last year. Rates are now capped at 10.5%.
• In 2014, the White House expanded the eligibility criteria for the Pay as You Earn (PAYE) student loan repayment plan. For successful applicants, monthly student loan payments are capped at 10% of discretionary income.

What to do

“The key is to think ahead and figure out how much in college expenses you can afford,” says Keith Bernhardt, vice president of retirement and college products at Fidelity. (Read Viewpoints: “How much college can you really afford?”)

Once you have determined how much you can afford, focus your application process on colleges that fit your budget. Fill out the Free Application for Federal Student Aid (FAFSA) form to find out what grants, scholarships, and financial aid packages each college offers based on your family’s expected contribution. Finally, compare total costs.

“If you need to borrow, look first at student federal loan options, because they generally have better rates and repayment terms,” says Bernhardt. Also, consider looking at state-sponsored loans, or visit your state’s higher education office. For a list of such institutions, visit Ed.gov.

Borrowing options

When shopping for federal student loans, keep in mind that there are two types—need based and non–need based. Federal Perkins loans and subsidized Stafford loans are need based. Federal parent PLUS loans and unsubsidized Stafford loans are not, although parent PLUS loans have eligibility restrictions. Consider each of these loan programs, as well as taking out a home equity loan or line of credit, if available.

In financing your student’s college education, it’s important to shop based on a variety of factors, including loan availability, interest rates, loan terms, and flexibility of payments. For example, let’s say you need to borrow $30,000. As you can see in the chart to the right, your interest rates and monthly payments can vary considerably—but so can the structure of your payments, including when you start and when the final payment is due, as well as your ability to qualify.

Federal loan options

Let's take a closer look at the options for federal student loans.

• Perkins loans—These loans are awarded to students with the highest need, based on a combination of parental income and other factors. Perkins loans are offered to undergraduates for up to $5,500 a year, with a lifetime maximum of $27,500. Graduate students can borrow up to $8,000 a year, with a maximum of $60,000, including the loans they took out as undergrads. The interest rate is fixed at 5%, and there are no origination fees. Borrowers have up to 10 years to repay their loans, depending on the amount owed.
• Subsidized Stafford loans—Eligibility for these loans is determined by FAFSA. Typically, they are offered at set amounts for each school year—from $3,500 for the first year up to $5,500 in the third year and beyond—with a lifetime limit of $23,000. As of July 1, 2016, the interest rate is 3.76%. Interest begins accruing upon graduation or leaving school. Standard repayment is a 10-year term, but borrowers can apply for extended repayment options of 10 to 30 years, depending on the amount owed.
• Unsubsidized Stafford loans—To receive these loans, students must be enrolled in a qualifying degree or certificate program. Interest rates are 3.76% for undergraduate students for the 2016–2017 school year and 5.31% for graduate students, with extended repayment options of up to 30 years, though borrowers must apply and be qualified for extended repayment options such as income-based repayment. Loan limits vary from $5,000 to $12,500 a year for undergrads, with a lifetime limit of $31,000 for dependent undergrads and $57,500 for independent undergrads. Unlike subsidized Stafford loans, interest on the unsubsidized variety accrues from the time they are disbursed, rather than when the student leaves school.
• Parent PLUS and graduate student PLUS loans—These loans carry a 6.31% fixed rate in the 2016–2017 academic year and are available to graduate students and to parents of undergrads. Unlike Stafford loans, PLUS loans require underwriting, and standards have tightened. To qualify, recipients cannot have an adverse credit history, which includes bankruptcy and unpaid collection accounts and charge-offs. You can appeal a denial by providing added documentation or an endorser. Undergraduates whose parents are denied a PLUS loan are eligible for an additional $4,000 to $5,000 in unsubsidized Stafford loans a year. The bad news is that those who are denied a PLUS loan are unlikely to qualify for private loans. Loan terms can range from 10 to 30 years.

Beyond federal loans

Keep in mind that there are other college financing options beyond federal loans.

• Private student loans are available, but they typically carry variable interest rates as high as 12%, and they often reset each quarter. Unlike federal loans, most come with a repayment period of up to 20 years, versus 10 to 15 years for federal student loans. Private loans typically are stricter in their selection of borrowers as well. Your credit rate may cause you to pay a higher or lower interest rate, or be denied for a loan altogether. More than 90% of private student loans require a cosigner. Still, private student loans may be an option for some students, especially if they can qualify for a relatively low rate.
• State-sponsored student loans are loans that have your state’s stamp of approval. These loans vary from state to state but in general are designed with the consumer in mind. Interest rates vary, but generally they range from 5.0% to 8.5%. Some states offer attractive features like interest rates that are fixed or the absence of tiered rates that are based on the borrower’s credit score.
• Home equity lines of credit or home equity loans are another popular option. Home equity lines of credit carry a variable interest rate recently averaging about 4.74%; the rate on home equity loans is fixed, averaging 4.92% as of July 2016, according to Bankrate.com. With the equity line, you have the flexibility to borrow money when you need it, and avoid paying interest on money you don’t need yet. Home equity loans are generally given by a lump-sum amount in the beginning, and you will have to estimate all your future expenses at that time. However, with both a home equity loan and a home equity line of credit, you use your home as collateral, and risk losing it if you violate the repayment terms. Either way, the advantage over education loans is that you can deduct the interest on home equity debt up to $100,000.

Tips for students

For students already enrolled in college or graduating with outstanding debt, here are some tips to understanding, managing, and paying off loans:

1. Understand the terms and conditions of your loans and be sure to meet your monthly payments.
2. Take advantage of private and government websites and resources; explore alternatives designed to lower payments, and tuition management assistance programs.
3. Check whether you qualify for a deduction of your student loan interest when doing your taxes.
4. Visit the National Student Loan Data System to keep track of your loans and financial services provider.
5. Opt to repay your student loans via automatic deductions from your bank account, which can help avoid penalties. Repaying student loans automatically not only avoids late fees but may also yield a slight interest rate reduction.
6. Pay off the highest interest rate loans first to save money in the long term.