College students: Welcome to the debtors clan.
If you are like most students, you will need student loans to pay for college. And while that’s a scary thought for some, there is no reason to fret.
Despite all the headlines about ruinous student loans, taking on some loans to go to college is not inherently dangerous if you pay attention to the type of loans you choose and are honest with yourself about your career plans.
That’s true even if you borrow the full $27,000 over four years that the federal government will let you borrow with federal Stafford Loans, said Mark Kantrowitz, president of MK Consulting. As a rule of thumb, he notes, students should not borrow more than they will earn each year on a first job out of college. And since the National Association of College Employers reports graduates earning $35,000 to $55,000, $27,000 is manageable, he said. But here are four college loan lessons to follow.
▪ Pick the right loans: If you go online and type in “student loans,” you will be off to a bad start. The first loans to pop up are private loans. In other words, they are provided by banks or other lenders. Since those lenders need to make a profit, these loans typically are not the best. They can lock you into payments that might be tough to afford, and they don’t give you a way out if you lose your job or get a low-paying job.
Instead, take out only federal student loans, which are called Stafford Loans and Perkins Loans. Check out the U.S. Department of Education site and insist on federal student loans when talking with your college financial aid office.
If you can’t get a job after college, or get fired or end up with a low-paying job any time while paying off your loans during 10 years, federal student loans cut your payments to affordable rates. If you haven’t earned enough to pay off your loans in 20 years, the government lets you off the hook. Private lenders generally don’t do that.
▪ Know your interest rate: If you get a federal Stafford Loan this year you will pay 3.76 percent in interest, which is a very low interest rate – the type you want. But be aware: Some private lenders might show you a lower interest rate online that may look tempting. The trouble is, this is probably going to be a “variable rate,” which means it won’t stay low continually. As the months and years go by, a variable rate changes your interest rate. So the interest rate can jump higher – probably a lot higher than you see now.
One reason you want federal student loans, instead of private loans, is that both Stafford and Perkins loans have “fixed rates” that won’t change as you pay off the loans a little each month for up to 10 years. So if you borrow the full $5,500 the federal government will allow in Stafford loans for a college freshman this year and the interest rate is 3.76 percent, you will pay roughly $55 each month for your loans and a total of about $6,600 over 10 years. As a comparison, with a 6 percent rate, you’d pay $61 a month and a total of $7,330 over 10 years.
▪ What if you need to borrow more: The second year you are in college, the federal government will let you borrow a little more: $7,500. For a four-year education, your federal loans can total $27,000. The government holds you back early in college because too many students drop out and hurt themselves. They have large loan burdens, and can’t get the kinds of well-paying jobs available to college graduates.
So beware of taking on private loans to supplement your federal student loans if you are just experimenting with college. If you are committed and need more money, your parents may help with federal Parent PLUS loans. These carry interest rates of 6.31 percent. Private loans may offer better rates for parents with excellent credit scores, but Kantrowitz notes one advantage with the federal PLUS loans: If a parent dies or is disabled, the debt is forgiven.
▪ Not all colleges are equal: Before taking on a lot of debt, consider whether your pay after college is likely to be adequate for your level of debt. If, for example, you will be a preschool teacher earning $30,000, you don’t want $50,000 in debt.
Also check the College Scorecard for the college you will attend. Graduates of some weak colleges have trouble afterward getting jobs or paying off loans. If you find a troubled school, consider another or limit your borrowing.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author. Email: firstname.lastname@example.org.