We're in the financial season when families with college age students are figuring out how they'll pay the tab. Most will take out student loans. Question is, what kind of student loans? Federal? Private?
Private student loans are in the spotlight. For example, the Wall Street Journal recently ran an intriguing analysis, "The New Math of Student Loans." The core of the argument is that for those with high credit scores and comfortable finances, private student loans are attractive since they come with a lower interest rate than federal student loans. At the same time, some private lenders are showing a willingness to restructure debts if a borrower runs into trouble.
To be sure, private loans may make sense for a small slice of creditworthy households that don't need to borrow for college. The loans simply reflect a household money management strategy. For these borrowers, all that matters is the interest rate. For everyone else, despite the higher interest rate, I believe federal student loans are the best option by an overwhelming margin.
For one thing, private student loans for undergraduates require a co-signer to get an attractive rate. The co-signer is on the hook for loan repayments if the borrower falls into financial trouble. For another, at the same time that some private lenders are trying to be more borrower-friendly, others are turning to the courts to collect on defaulted loans. Loan modification terms vary among private lenders. I still like the old math.
The real appeal of federal student loans is the financial flexibility built into the repayment system. When indebted newly minted college graduates lose their job or can't find work with decent pay, the federal loans offer a number of repayment options to buy financial relief. For example, most borrowers can slash their monthly tab by shifting into the income-based repayment plan option — a valuable safety net.
Even as the job market improves, many students still struggle. The uncertainty inherent in the search for jobs and careers in a hypercompetitive global economy is an argument for embracing flexibility with debts, especially student loans.
Of course, the price for easing federal loan terms is a potential increase in the overall student loan tab. Since federal student loans don't come with a prepayment penalty, you can always accelerate payments later.
Chris Farrell is senior economics contributor, Marketplace, and commentator, Minnesota Public Radio.