Q: Can you tell me why the private student loan is not the way to go, why a federal student loan is a better option? Who do we contact for federal loans?
A: At the time I’m writing this column, the federal student loan market is in turmoil, thanks to a dysfunctional Washington. The rate on federal student loans doubled from 3.4 percent to 6.8 percent at the beginning of the month, an outcome no one in Washington really wanted but couldn’t prevent. Private loan interest rates are typically higher than federal student loans, although that won’t be the case in some instances if the rate hike to 6.8 percent sticks.
Not many students have been affected by the rate increase — yet. It’s likely a bill will get passed that retroactively brings down the rate.
Nevertheless, the reason I don’t like private student loans has little if anything to do with the interest rate. The big advantage offered by federal student loans is financial flexibility when students graduate. College graduates get into financial binds. They can lose their job, have trouble finding work with decent pay and maybe fall sick. Graduates have a number of options to buy themselves financial relief with federal student loans.
For example, with economic hardship, graduates can apply to suspend repayments for up to three years. They can slash their monthly tab by shifting to the income-based repayment plan or contingent-income option.
The price for taking advantage of easier loan terms by choosing an option that stretches out payments is an increase in the cost of the overall loan.
However, since there’s no prepayment penalty with federal student loans, the borrower can always accelerate payments later on when their financial circumstances improve. In other words, graduates with federal student loans have the ability to maneuver for some relief, hopefully without boosting by much the overall price tag.
Private student loans are more like credit cards or personal loans. Although some private lenders offer their borrowers some flexibility, it pales next to federal student loans. Despite their “student loan” label these are really nothing more than old-fashioned consumer installment loans.
Traditionally, the private loan market was relatively small. Students used them to borrow a limited amount of money to finish a credit or a semester. That was OK and any financial hardship minimal. The growing concern about private student loans is that the amounts borrowed have gotten far too big for such an inflexible loan.
Another factor weighing against private student loans is that parents (or some other adult like a grandparent) usually cosign the loan to enable a student to obtain the best interest rate. The co-signer is on the hook for loan repayments if the borrower can’t meet the monthly tab. Like federal student loans, private student loans can’t be discharged in bankruptcy.
The Department of Education (www.ed.gov) is one portal into financial aid and student loan options. I would also visit the FinAid website (www.finaid.org). FinAid is comprehensive on the student loan market, and it goes into much more detail about the factors to think about with student loans — both federal and private.
Chris Farrell is economics editor for “Marketplace Money.” His e-mail is email@example.com.