Scoring a Private Loan for College
Families often turn to private loans to bridge the gap between the cost of college and the maximum $5,500 a year undergraduates can borrow in federally backed student loans. But the credit crunch means those seeking private loans for the coming academic year are likely to encounter problems, from higher interest rates to lenders that balk at making loans to any but the most creditworthy. "It's more important than ever for families to plan in advance," says Kevin Walker, CEO of Simple Tuition, which runs a Web site that lets borrowers compare offerings from lenders that pay it for placement.
What's a good strategy? Before deciding to take out a private loan, carefully consider the alternatives. With variable rates now ranging from 6% to 16% and fees as high as 11.5%, private student loans are typically more expensive than federally backed Stafford Loans for students. These carry a maximum fixed interest rate of 6.8%, while PLUS Loans for parents charge 8.5%. Stafford Loans limit undergraduate borrowing to $3,500 for freshman year, $4,500 for sophomore year, and $5,500 annually thereafter, but PLUS loans allow parents to borrow up to the full cost of attendance.
Some states also offer bargain-rate loans to those who live or attend college within their borders. Examples include the Massachusetts Educational Financing Authority's MEFA Undergraduate Loan and the New Jersey Higher Education Student Assistance Authority's NJCLASS loan. "Private loans should be a last resort," says Kalman Chany, author of Paying for College Without Going Broke (Princeton Review; $20).
Still, many families gravitate to private loans, in part because they leave the student, not the parent, on the hook for repayment. Moreover, those unable to qualify for federal loans, including foreign students and those with grade point averages below 2.0, may have no choice but to use private loans, says Mark Kantrowitz, publisher of financial aid Web site FinAid.org.
When loan shopping, don't simply pick the lender advertising the lowest rate. Because interest rates depend mainly on a borrower's credit score, the percentage an individual pays may well be higher. Even students with relatively sound credit typically come out ahead by asking a relative or a friend with a more established credit history to co-sign a loan's promissory note. (Co-signers are responsible for repayment should the student default.)
EASY ON THE APPS
To compare rates, fill out applications with more than one lender. But don't cast too wide a net. Each new application can reduce your credit score by five points, says Kantrowitz, who figures more than five new applications would damage your credit score enough to cause a lender to charge a higher interest rate. "Credit bureaus view a lot of loan inquiries as evidence that you're trying to load up on debt," says Robert Shireman, executive director of nonprofit Project on Student Debt, who recommends applying to three or four lenders within a few days.
Which are likely to offer the best rates? Ask your school's financial aid office whether it has negotiated any special deals. Then check with state-affiliated nonprofits, such as South Carolina Student Loan Corp. The credit crisis has driven several lenders to suspend at least some student loan operations. But those still offering private loans tend to offer competitive rates and fees.
Students without a co-signer may want to consider a private loan that does not depend on credit scores. One of the few such offerings, MyRichUncle's (UNCL) PrePrime product, uses criteria including a student's college and GPA (or high school records) to assess the risk of a default. Another way to scout for relative bargains: Look for lenders that offer low rates to applicants with unblemished credit. Then zero in on those with narrow spreads between their best and worst rates. FinAid.org publishes the range for various lenders at finaid.org/loans/privatestudentloans.phtml. "If the spread is narrow and the lender's best rate is attractive, it increases your odds of getting a good deal," says Kantrowitz.
Amid the credit crunch, lenders are triming the discounts they offer on fees and rates. But borrowers who agree to make payments while in school may still qualify for a lower rate. Finally, given a choice between two loans with the same overall interest rate, favor those pegged to the London Interbank Offered Rate (LIBOR) that banks charge each other over the prime rate U.S. banks give their most creditworthy customers. (Your lender will disclose which index serves as the basis for your loan.) For years, the gap between prime, now 5.25%, and three-month LIBOR, now 2.92%, has grown. If the trend continues, "over the long term, a loan based on LIBOR will be less expensive," says Kantrowitz. With rates rising on these already costly loans, every bit of savings counts.