How to Choose the Best Student Loans

What types of education loans are the best student loans?

Borrow federal first, because federal student loans are less expensive, more available and have better repayment terms than private student loans. Federal student loans have fixed interest rates that will not increase over the life of the loan, unlike variable interest rates which can change. Perkins Loans and Direct Subsidized and Unsubsidized Loans do not depend on the borrower’s credit history and do not require cosigners. Federal student loans offer generous deferment and forbearance options, flexible repayment plans like extended repayment, graduated repayment, and income-driven repayment, and opportunities of loan forgiveness programs like public service loan forgiveness.

Private student loans should be considered only after reviewing federal education loan options. And what some students may learn, federal education loans may not be an option. Some reasons could be, the student may have reached the loan limits or otherwise have lost eligibility for federal student loans (e.g., dropping below half-time enrollment or failing to maintain satisfactory academic progress). The student’s parents may be unwilling or unable to borrow from the Parent PLUS Loan program. Private student loans may be available for previous school charges, for borrowers who are not seeking a degree or certificate (e.g., continuing education), for international students (usually with a creditworthy U.S. citizen or eligible non-citizen as cosigner), and for education costs incurred after graduation (e.g., bar study loans for law school graduates and residency and relocation loans for medical school graduates).

The Best Loan is the Lowest Cost Loan

For most borrowers, the best loan is the loan with the lowest cost. There are many factors that contribute to the cost of a loan, including interest rates, loan fees, subsidized interest, and loan forgiveness, discharge, and cancellation.

• The higher the interest rate, the higher the cost of the loan. A loan with a variable interest rate might initially have a lower interest rate than a fixed-rate loan, but the interest rate may increase over the life of the loan. For example, a variable-rate loan may start with an interest rate that is competitive with the interest rate on PLUS Loans, maybe even a percentage point lower, but that interest rate might increase by a percentage point or two each year for several years, ultimately costing much more than the fixed-rate federal education loans.
• Loan fees are a form of up-front interest. While they are non-negotiable with federal education loans (these will always have a loan/origination fee), private student loan lenders may offer options without loan fees.
• Subsidized interest is the equivalent of having a 0% interest rate during the in-school period and other periods of authorized deferment, because the federal government pays the interest on subsidized loans while the borrower is enrolled in school on at least a half-time basis.
• Loan forgiveness or discharge cancels all or part of the debt, directly reducing the cost of the loan.

Ranking the Best Loans

The best federal education loans are the Direct Subsidized Loan. This loan has subsidized interest, fixed interest rates, and low fees. Next are Direct Unsubsidized Loans, followed by the PLUS Loan. Private student loans have interest rates that depend on the borrower’s credit scores and debt-service-to-income ratios, as do home equity loans and other non-education loans. Most private student loans require a creditworthy cosigner. Credit cards often have some of the highest interest rates and require monthly payments that start off higher and gradually get smaller, because the monthly payment is usually based on a fixed percentage of the outstanding loan balance.

Federal and private student loans do not require the borrower to pledge a home or other asset as collateral. In other words, these are unsecured loans. If the borrower defaults on a home equity loan, he or she can lose the home. If the borrower defaults on a student loan, the lender cannot repossess the student’s education.

This chart compares some of the major features of federal and private student loans.

After cost, secondary factors that can help distinguish loan programs include who is responsible for repaying the debt (e.g., the student or the parent/cosigner), flexible repayment and deferment options, and the quality of lender customer service.