You might not use the word “good” to describe student loans, but not all of them are bad.
A truly bad loan has high interest rates, few repayment options or little help if you have trouble making payments.
Taking time to assess loan features is key to avoiding a bad one, says Kevin Fudge, director of consumer advocacy and the ombudsman for American Student Assistance, a nonprofit focused on helping students pay for college.
Before evaluating any loan offer, first maximize whatever free money you’re eligible for. This may include grants, scholarships and work-study. Then, consider these three borrowing tips to avoid a bad student loan:
1. Choose federal loans first
If you have to borrow, choose federal loans before private. Loans through the federal government offer more borrower-friendly options, such as income-driven repayment and public service loan forgiveness, and don’t require established credit.
If you’re left with a payment gap to fill, compare offerings from a variety of private lenders.
Fudge touts the benefits of local banks over large companies for customer service. “You can walk into a local branch and talk to someone versus calling a 1-800 number and being lost in the push-button wilderness,” he says.
When comparing loans, decide what terms are most important to you. This could include a longer grace period, more repayment options, the option to release a co-signer and opportunities to hold off repayment temporarily.
2. Check forbearance terms
While repaying your loan, you may run into difficulty meeting monthly payments. One way to avoid missed payments is by using forbearance. It allows you to pause payments on your loan for a short period of time, while interest continues to build. Forbearance is typically offered in three-month increments, for up to 12 months. Some lenders may offer up to 24 months of forbearance.
If a lender doesn’t list its forbearance option, they may grant it on a case-by-case basis. It’s safer to choose a loan with a more transparent policy in place.
3. Choose a fixed-interest-rate loan and look for hidden costs
Private lenders may offer both variable and fixed-interest rates. Go with a fixed rate that will stay the same throughout repayment. A variable rate may initially be lower than a fixed rate, but it can increase over time. That’s because variable rates are tied to a financial market index; when the index changes, so does the rate.
In addition to interest rates, look for hidden costs, such as fees. “A bad loan is one that advertises a low interest rate, but has an origination fee that masks the true costs of the loan,” says Thad Spalding, executive director of the office of financial aid and scholarships at Metropolitan State University of Denver.
Search for fees and penalties, such as an origination fee, late fee or prepayment penalty. An origination fee could alternately be labeled “loan disbursement fee” or “administrative fee.”
Securing the lowest fixed rate you’re eligible for is important to your overall savings. Even 1 percent makes a difference. For example, if you borrow a $10,000 private loan with an interest rate of 6.5 percent, you’d pay about $3,600 in interest over a typical 10-year term. Instead, if you borrow the same amount at an interest rate of 5.5 percent, you’ll see an interest savings of more than $600.