The lowdown on college loans

No doubt about it: There are better ways to pay for college: The first choice is with scholarships and grants—free money that’s awarded to a student based on financial need or in recognition of academic, athletic, or extracurricular skills. Then there’s savings—you know, all that cash you’ve been squirreling away in anticipation of this moment since your teen was a toddler.

If, however, you’re like most American families—even those lucky enough to have the first and second choices covered—you may also have to rely on loans. According to the U.S. Department of Education, two-thirds of students in bachelor’s programs borrow money for college. But before you take on debt, it pays to get up to speed on the various types of loans available and the recent developments that have affected them.

Federal student loans. Since the government started subsidizing college loans four decades ago, these have been the top choice for student borrowers—and with good reason: They typically offer the lowest interest rates and most favorable repayment terms, particularly if you can demonstrate financial need. Now, thanks to reforms that were part of the major health-care overhaul in March, federal loans have become even more attractive.

As of July 1, students who want Stafford or Perkins loans will borrow directly from Uncle Sam instead of from a private lender. (Under the old system, banks administered federal loans even though the government guaranteed them; the reform essentially cuts out the middleman.) Financial aid officers say this so-called “direct lending” will eliminate confusion and streamline the application process. What’s more, under the new law, repayment of money borrowed after 2014 will be limited to 10 percent of a graduate’s annual income, with any remaining balance forgiven after 20 years. Graduates who work in public service professions or in the military can have their loans forgiven after 10 years.

State student loans. If federal loans aren’t sufficient, New York also has money to lend. Students can borrow a minimum of $2,000 a year or a maximum of $50,000 over four years of college. Interest rates vary, but they’re typically lower than what’s offered by private banks. For more information, go to the website of the New York State Higher Education Services Corporation at hesc.com.

Federal parent loans. In addition to money that a student borrows, parents can take out a federal PLUS loan to help with college costs. Also as of July, these will be made directly through the government and will carry an interest rate of 7.9 percent. (Currently, some PLUS loans are administered by private banks, which typically charge 8.5 percent interest.) PLUS loans are available to all families regardless of financial need; borrowers must qualify through a simple credit check.

Private loans. After you’ve exhausted all government options, you may also need to consider a private loan from a bank or a college. Many schools supply a “preferred lender” list, but families should investigate thoroughly to make sure they’re getting the best deal. (In recent years, New York Attorney General Andrew Cuomo cracked down on some deceptive practices in the student loan business, so most of these are now on the up-and-up.) Still, you are under no obligation to use the lenders the school recommends. For help comparing private loan options, go to finaid.org or financialaidfinder.com.

Home equity loans. When it was a booming housing market, some experts said that borrowing against your house was a smart way to help defray college costs. Today? Not so much. Rules have changed regarding tax deductions for interest payments, and housing values have declined, making it a risky proposition for many families. In certain cases, this might still make sense, but you should talk to a financial planner before borrowing against your home.

P2P loans. Peer-to-peer (or social lending) is one of the newest options around: Using a P2P website, a borrower arranges a loan from an individual or a group of people, with terms worked out on a case-by-case basis. Depending on the site, the lenders are either friends and family members, or even strangers who are willing to make an investment in someone’s education. The most established social lending sites include Green Note (greenote.com) Virgin Money (virginmoney.com) and Lending Club (lendingclub.com).

Smart Borrowing Tips
Know all the costs. Use an online calculator to determine your payments—and to know the full cost over the life of the loan.
Don’t over borrow. Though you may qualify for a bigger loan, taking on more debt than necessary is a bad idea.
Read the fine print. Don’t sign on the dotted line until you understand all the terms. If you’re confused, ask an accountant or financial planner for help.