There are two main types of student loans, federal and private.
You should always borrow federal first, as the federal loans are cheaper, more available and have better repayment terms. The interest rates on federal loans are fixed while the interest rates on private student loans are variable. Federal loans will generally cost you less money over the term of the loan. The unsubsidized Stafford loan and the PLUS loans do not depend on financial need, so you don't need to be poor to qualify for low-cost federal education loans. Private student loans are more expensive, and are mainly for filling the gap when you've exhausted your federal education loan limits or are ineligible for federal education loans.
The federal education loans include the Perkins Loan, Stafford Loan, PLUS Loan and Consolidation Loan.
The loan limits on the Stafford loan depend on year in school and dependency status.
There are a variety of criteria for independent student status, but the most common ones include: age 24 or older as of December 31 of the award year, married, having dependents other than a spouse, being a graduate or professional student, or being a veteran or active duty member of the Armed Forces.Â
Independent students can borrow up to $9,500 in unsubsidized Stafford loans as a college freshman, $10,500 as a sophomore, $12,500 as a junior and $12,500 as a senior. There is also an cumulative borrowing limit of $57,500.
Dependent students can borrow up to $5,500 in unsubsidized Stafford loans as a college freshman, $6,500 as a sophomore, $7,500 as a junior and $7,500 as a senior. There is also an cumulative borrowing limit of $31,000. The subsidized Stafford loans are limited to $3,500 for college freshmen, $4,500 for sophomores, $5,500 for juniors and $5,500 for seniors, with an cumulative limit of $23,000. Any amounts received as a subsidized Stafford loan are subtracted from the corresponding unsubsidized Stafford loan limits. (Graduate and professional students can borrow up to $20,500 a year, no more than $8,500 of which can be subsidized.)
Starting July 1, 2010, all new federal education loans will be made through the Direct Loan program. To apply for these loans, contact the financial aid office at your college. After you tell the college how much you wish to borrow (up to the annual and cumulative loan limits), they will ask you to sign a Master Promissory Note (MPN). You will have to sign the MPN only once per college, as it is valid for all your federal education loans while you are enrolled.
Private student loans base eligibility and the interest rates on your credit score and the credit score of your cosigner. You have to have very good or excellent credit to qualify for a private student loan on your own. Most students will need a creditworthy cosigner in order to qualify. Even if you can qualify on your own, it can be worthwhile to apply with a cosigner if the cosigner has a better credit score, since this can reduce the interest rate on the loan.
Federal education loans offer a variety of repayment plans. The standard repayment plan has a 10 year repayment term. Extended repayment increases the term to up to 30 years, depending on the amount you owe. For example, the repayment term can be 20 years if you owe at least $20,000, 25 years if you owe at least $40,000 and 30 years if you owe more than $60,000. Graduated repayment starts off with lower payments and increases them every two years.
Income-based repayment is available only for federal student loans, not Parent PLUS loans (or private student loans) and pegs the monthly payment to 15% of your discretionary income, with any remaining debt forgiven after 25 years. (The monthly payment under income-based repayment is 10% of discretionary income for new borrowers of new loans made on or after July 1, 2014, and the remaining debt is forgiven after 20 years.) Borrowers who repay their loans under the income-based repayment plan while working full-time in a public service job can have their remaining debt forgiven after only 10 years. Public service jobs include teachers, police, fire, public defenders, prosecutors, public and school librarians, military and anybody working for a tax exempt non-profit organization, not just people who work for the government.
Increasing the term of the loan will reduce the monthly payment but increase the cost of the loan. For example, increasing the term of an unsubsidized Stafford loan from 10 years to 20 years will cut the monthly loan payment by a third, but will more than double the interest paid over the life of the loan (a factor of 2.18 increase in total interest). If you can afford it, use as short a loan term as possible to help pay off the debt more quickly and save money.
A total of up to $2,500 a year in student loan interest can be deducted as an above-the-line exclusion from income on your federal income tax return. You can take this deduction even if you don't itemize. The deduction includes both federal and private student loan interest.
Many colleges offer payment plans or tuition installment plans as an alternative to loans. These installment plans let you spread out the college costs into 9 or 12 equal monthly payments for a small up-front fee. This can be a convenient option if you can afford to pay the college bills, just not all at once.
Mark Kantrowitz is an expert on paying for college. He is publisher of FinAid.org and Fastweb.com, the leading free web sites for information about student financial aid, student loans and scholarships.