Borrower, Be Wary

Those student loan rebates and discounts aren't always as alluring as they seem. You have to scrutinize the terms to get a good deal

Shopping for a student loan should be a snap. After all, the U.S. government caps the interest rates and fees on federally backed college loans, which account for the vast majority of borrowings. What complicates the process is that lenders try to lure borrowers with an array of interest-rate discounts and rebates on fees and principal, all of which make apples-to-apples comparisons nearly impossible for parents, let alone college kids. "Only a banker has the expertise to calculate the best financing option," says Nancy Hoover, director of financial aid at Denison University in Granville, Ohio.

No wonder many colleges—Denison being one of the exceptions—have "preferred lender" lists that students and parents might see as an imprimatur that the deals are among the best available. They may be, but the trouble is that some lenders have bought their way onto these lists through payments to the school or, in rare cases, to the financial aid officers. Such arrangements have sparked an ongoing investigation by the New York Attorney General's office, which has reached agreements with more than two dozen schools, including Fordham, Syracuse, and New York universities, to distribute to students the money the lenders paid them. So you shouldn't just blindly accept advice from the school's financial aid office. You can get yourself a good deal if you know how to look.

PLOT STRATEGY

The first step is to fill out the paperwork. Start with the Free Application for Federal Student Aid (FAFSA) at fafsa.ed.gov. Even those who don't qualify for aid should fill it out, since FAFSA is a requirement for certain bargain-rate government-backed loans. In addition, you'll have to complete an application for each loan you apply for.

Stafford Loans, which are issued to students, carry the lowest interest rate, a maximum of 6.8%. Government-backed PLUS loans go to parents and currently charge 8.5%. These loans have other advantages: Anyone can qualify, regardless of income, and borrowers who encounter financial hardship can request that repayments be suspended or reduced. Starting on July 1, undergraduates can borrow up to $3,500 for their freshman year with a Stafford Loan, $4,500 in their sophomore year, and $5,500 annually thereafter, for a total of $23,000. Because of the low interest rate, students generally choose to borrow the maximum. Parents can then follow with a PLUS loan for the balance of what's owed for tuition, room, board, and fees—or if they choose, up to the full cost of attendance.

If students need more than what parents will contribute or borrow, they can seek private loans, offered by a wide variety of lenders including Sallie Mae (SLM ) and Citibank. (C ) But with variable rates that generally range from 8% to 18% and fees as high as 11.5%, these can saddle young graduates with far higher interest payments than the alternatives available to parents. Parents reluctant to add to their debt can always take a PLUS or a home-equity loan that the student agrees to pay back.

COMPARE OFFERS

Most Stafford and Plus loans feature at least one of three types of discounts: fee waivers, principal reductions, and interest-rate reductions. To crunch the numbers, use the calculator at FinAid (finaid.org/calculators/loandiscountanalyzer.phtml). It figures in the impact of fee reductions and other discounts and comes up with a "discounted interest rate." For instance, the discounted rate on a Stafford Loan from MyRichUncle is 6.03%, vs. 6.88% from Carnegie Student Loans.

FinAid.org maintains a list that summarizes discounts available from various lenders. The site accepts advertising—its current sponsor is Citibank (C )—but it does not take payments from other lenders. Some other sites do.

As a rule, favor discounts that kick in early in the life of a loan and cannot be canceled. These include fee waivers and automatic interest-rate cuts for signing up for direct payments from your checking account. Some lenders, including MyRichUncle, Maine Advantage Education Loan Program, the Michigan Higher Education Student Loan Authority, the Missouri Higher Education Loan Authority, and NorthStar, take a percentage point or more off their rates, with no or few strings attached. (Michigan and Maine require borrowers to live or attend school in state.)

When comparing these deals, remember that rate reductions are generally more valuable than fee waivers or principal rebates. According to FinAid Publisher Mark Kantrowitz, fees on a 10-year loan would have to fall four percentage points to equal the savings you could achieve with a one-point interest-rate reduction that starts at repayment.

In contrast, discounts contingent on good behavior—such as paying on time for the first 48 months—are less valuable. Fewer than 10% of borrowers ever qualify. Moreover, these reductions kick in only after you've already repaid a big chunk of the loan. As a result, while a two-point rate break after 48 months into a 10-year loan sounds great, it's equal to a 0.63-point rate cut for the life of the loan. Before committing, read the fine print to make sure you won't lose your benefits or be forced to repay discounts if your loan is sold or you opt to consolidate with another lender.

THE LAST RESORT

If a student has no choice but to go with a private loan, don't simply pick the lender advertising the lowest rate. Payments will ultimately be determined by the borrower's credit score. Even students with relatively sound credit histories will typically come out ahead if a parent co-signs the promissory note.

To compare rates, apply to more than one lender. But first, ask your school's financial aid office if it has negotiated any special deals. Many do, which is why you still shouldn't overlook preferred lender lists.

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By Anne Tergesen

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