1.Your co-signer could do you more harm than good
Before they will lend thousands of dollars to a college-bound 18-year-old, many lenders will require a cosigner. Approximately 80% or more of private loans have a cosigner, according to the Consumer Bankers Association. Typically, that's a parent or another relative, but it can be anyone willing to take responsibility for paying back the loan. Private lenders often tout the benefit of an adult cosigner, saying that because students don't have much of a credit history, the a co-signer's good standing can help secure a lower interest rate. That's true, but it also puts the student at the mercy of the parent's credit history, which may not be so stable these days.
And if a parent's credit standing falls, the interest rates families get on private loan when the student is a freshman in college might be the lowest they'll ever see. Each year a student applies for a private loan, the lender takes a fresh look at his cosigner's credit profile. If the lender sees a lower credit score, more debt or missed payments to other lenders, it will likely offer a higher interest rate on a loan than it did when the student was a freshman in college. Falling credit is a sign of a riskier borrower, says a spokeswoman for the CBA, which warrants higher rates.
2.You may be in over your head
When Jason Wagner was studying to be a pilot at Embry-Riddle Aeronautical University in Prescott, Ariz., he figured he'd have no trouble landing a job and making payments on what eventually totaled $130,000 in mostly private student loans. But in the seven years since he graduated, it's been harder than he thought. In 2008, he worked out an agreement to lower his monthly loan payments, and next month, for the first time, he says he will probably miss a payment.
Wagner isn't alone. Nearly 10% of federal student-loan borrowers defaulted during the two years ended Sept. 30, 2010, according to the Department of Education, up from 7% in 2008. Private student loan defaults are rising also: Around 5.4% of private student loans defaulted during the second quarter of this year, up from 4.5% a year ago, according to Moody's Investors Service Private Student Loan Indices, which tracks loans. Getting back on track after defaulting is difficult: college graduates' credit scores can plummet, which can make it difficult to get approved for credit or to rent an apartment. And critics say many graduates who are dealing with overwhelming debt loads try to find jobs with salaries that allow them to pay back the loans, instead of a job they want.
For its part, Sallie Mae, the largest private student lender, says it wants to help its customers graduate and be successful in repaying their student loan obligation so it does everything it can to assist them along the way to achieve those goals. Many private lenders allow delaying payments for a year. And students who have difficulty repaying federal loans may be able to sign up to delay payments for up to three years and in some cases forbearance for up to five years.
3. The more expensive your college, the cheaper your loans
Financial aid experts agree: the cheapest loan a college student can get is a government-sponsored subsidized Stafford loan. The rate is a rock-bottom 3.4% for the current academic year -- about less than half the cost of an unsubsidized Stafford loan -- and the government covers interest payments while the student is in college and for six months after graduation.
But to get approved for such a deal, students must demonstrate financial need, which is partly determined by the cost of their chosen school. That means a student at an expensive private college can show more need, and therefore, may get cheaper loans, than a student at a lower-cost school, says Mark Kantrowitz, publisher of FinAid.org and Fastweb.com.
This hidden incentive to choose a more expensive college is particularly powerful for students from wealthier families, because higher tuition costs can offset a higher family contribution, at least in the government's formula for demonstrated need. About one in four students from households earning $100,000 or more receive a subsidized Stafford loan when they attend a university that costs $40,000 or more a year, according to a study by FinAid.org. But only one in 14 do when they attend a school that costs $10,000 to $20,000. Of course, foregoing the loan in favor of a cheaper college may still be a better financial move overall, says Rod Bugarin, a financial aid expert at New York-based Aristotle Circle, which helps families get financial aid.
A spokeswoman for the U.S. Department of Education, which administers the Stafford loan program, noted that at any college, the maximum amount a dependent student can borrow in subsidized Stafford loans is $23,000. And that only goes so far at the most expensive schools anyway.
4. You're stuck with us -- forever
Facing almost $100,000 in student loans for two daughters' college educations and other debts, Eileen Pearlman, a speech language pathologist in Chicago, Ill., figured filing for bankruptcy would bring relief. She quickly discovered otherwise. Student loan debt can almost never be discharged in a bankruptcy. For example, of the 72,000 federal student loan borrowers who filed for bankruptcy in 2008, just 29 succeeded in getting part or all of that debt discharged, according to the most recent data from the Education Credit Management Corporation, which until recently provided guarantees for federal loans issued by private lenders. "You're more likely to die of cancer or in a car crash than you are to get your loans discharged in bankruptcy," says Kantrowitz.
And if you can't pay? The federal government can garnish up to 15% of the borrower's or cosigner's wages until the debt is paid off; private lenders can take up to 25%. For federal loans, the government can also intercept income tax refunds, future lottery winnings and up to 15% of Social Security benefits. And many private lenders, with the exception of Sallie Mae, Wells Fargo and the New York Higher Education Loan Program, can go after a borrower's estate upon his death. For families who have missed four to 12 months worth of payments, the most realistic option is to work out a payment plan with the lender, says Kantrowitz. With federal loans, for example, borrowers can clear a default from their record if they make nine out of 10 consecutive full on-time monthly payments.
5. Parents, you're off the hook -- kind of
Most private lenders require student borrowers to have a cosigner. It's most often a parent, but whoever it is, they're equally responsible for the loan until it's paid off. Few cosigners know, however, that most lenders allow the cosigner to exit the contract if loan payments are made on time for the first 12 to 48 months and the graduate has excellent credit.
But those terms are harder to meet than they first appear. For example, before Sallie Mae will approve a cosigner release for its most popular student loan, called the Smart Option, the lender says it needs to review the student's credit history for good standing with his or her other debts, including credit cards, car loans and even rent payments. In addition, the student needs to prove his income is high enough to manage the monthly loan payments solo.
The company says that the customers who meet the criteria do receive approval for a cosigner release after the first 12 months of on-time payments after graduation on a case-by-case basis. For example, a college graduate with $20,000 in federal loans, $10,000 in private loans and an annual salary of $45,000 (about average for recent grad) may be able to demonstrate sufficient income to handle the $125 in monthly private loan payments, the company says.
For parents who have cosigned for multiple private loans, it may be possible to exit the loan if the borrower consolidates. The cost, though, might be a more expensive loan for the student. In a consolidation, the borrower gets a new interest rate, and if his credit score is lower than his parents', the result could be a higher interest rate and larger monthly payments.
6. We'll spring for spring break
Federal and private loans don't just cover tuition and room and board. They also pay for what's called the cost of attendance, which includes, say, transportation to and from a student's hometown -- or other places, says Kantrowitz, which might include even Fort Lauderdale or Cabo San Lucas for spring break. Loans can also pay for health care expenses, computers and even winter clothes, says Bugarin.
To be sure, Bugarin says, what's covered by loans is largely determined by the college's financial aid office, and spring break trips don't usually get the green light unless they're related to an academic experience. "Financial aid officers are there to ensure that the student doesn't take on too much debt," he says. And students will have to provide documentation explaining why they need larger loans before a financial aid officer increases their loan size.
But even if an aid officer is willing to sign off, a larger loan may not be the best way to cover these expenses (see No. 4: "You're stuck with us -- forever"). A short-term alternative for miscellaneous expenses may actually be a credit card: Student cards now offer 0% interest rates for up to nine months, and parents may be able to qualify for a card with a 0% rate for nearly two years. That could be enough time to pay off those expenses without incurring interest.
7. The best colleges want nothing to do with us
Ivy League colleges are among the priciest in the country. They also have generous policies that guarantee aid in grants instead of loans to students who qualify for financial aid. In other words, for eligible families who can't afford the roughly $50,000 per year it costs to attend an Ivy League institution, the college will pick up the tab instead of saddling a student with loans. As a result, students tend to leave college with less debt. At Princeton, for example, 78% of graduating students have no debt, while the rest average $5,000 in loans, significantly less than the $27,000 national average.
It's a trend that's spread to other top-tier universities. In total, no-loans policies for all (or some) students are offered at 73 colleges and universities, according to FinAid.org, including Emory University, Stanford University and Wellesley College. The schools say the policies have helped them attract and retain the best students, regardless of family means, and that once students get there, they have the freedom to pursue studies that may not be lucrative. And after graduation, the policy "allows students to go into teaching and other professions without worrying if their salaries are high enough or if they can afford to make their student loan payments," says Robin Moscato, director of undergraduate financial aid at Princeton University.
8. You may not need us at all
To help students and their parents avoid mounting debt, about 90% of colleges offer tuition installment plans, according to the National Association of College and University Business Officers, which represents chief financial officers at nonprofit public and private institutions. Instead of having one or two big tuition bills due each year, the student owes a smaller amount each month for nine to 12 months. Most don't charge interest, though many do levy a one-time enrollment fee of around $50 to $75.
Of course, even spread out over the course of a year, tuition payments aren't small. Students who borrowed money to help pay for college last year took loans of about $7,400 on average, according to Sallie Mae -- an amount equal 12 monthly payments of $613. (Or nine monthly payments of $817.) Depending on the college and how much aid a family needs, that monthly installment could easily be more than $1,000. If parents or students fall behind, it is possible that the school could block the student from signing up for the next semester until payments resume, says Anne Gross, vice president of regulatory affairs at NACUBO.
Financial aid officers acknowledge the risks and say that tuition installment plans aren't for everyone, but that there are benefits. "Providing additional low-cost or no-cost payment options ultimately gives students and families more options to cover their educational costs," says a spokesman for the National Association of Student Financial Aid Administrators.
9. Variable-rate loans are a better deal -- for now
For people buying a house or a car, mortgage, lenders have offered fixed-rate and variable loans for decades. Until recently, student borrowers could only choose the latter, where interest rates can move up and down as often as each month. But this year, several large lenders rolled out fixed-rate options, where the rate (and monthly payment) is set today for the duration of the loan, and many financial aid experts have said they're safer and better for budgeting.
Right now, they're also more expensive. Among lenders that offer both fixed and variable-rate loans, the rates on fixed-rate student loans range from 6.25% to 14.25%, depending on the borrower's credit score and other factors, while variable-rate loans start as low as 2.89%. Of course, to get these super-low rates, students or their cosigners need a near-perfect credit score, and if interest rates start rising, these borrowers can except their rates to go up as well.
The Federal Reserve has announced its intention to keep interest rates low for another two years, which should keep many student loan rates unchanged. Families who can afford to pay off their loans while rates are still low are most likely to benefit from the variable-rate options; even so, the prime rate would have to rise to around 7% (from 3.25% currently) before the variable-rate loans get more expensive than the fixed-rate ones.
10. Business is good
In spite of high unemployment and growing default rates, borrowers have yet to tamp their appetite for loans. The number of students projected to get loans for the 2011-12 academic year has almost doubled in the last decade, according to FinAid.org. Over that same period, the number of parents signing up for loans to help their children has more than tripled. And average student loan debt at 2012 graduation is projected to be $28,720, up 60% from a decade ago. Proud parents on average will owe $33,798, up 123%.
After retrenching post-credit crunch, private lenders have begun to once again recognize the opportunity in this lucrative market. Around 24 private lenders are offering student loans now, up from 12 in 2008, according to FinAid.org. Financial aid experts say that as long as college tuition costs keep rising and families face tight budgets and high unemployment, that number is expected to keep growing.