Take time to carefully review your family’s financial situation and identify every financing resource available. Be sure to explore all options before applying for an alternative loan.
Alternative loans should be the last option a student should consider. The Federal Direct and the Federal PLUS loan programs are better options. If you need to borrow an alternative loan be sure that you have borrowed the maximum Federal Direct loan for which you are eligible. First year students may borrow up to $3,500; second year students may borrow up to $4,500; and for each subsequent year, $5,500; for an aggregate of $23,000. Students may borrow an additional $2,000 in an unsubsidized student loan in addition to each of the loan limits shown above.
Determine the total amount of education debt you and your family are willing to accumulate during the student’s college enrollment. Take into consideration the four years worth of federal student loan debt the student will be taking on as well as what income the student may realistically expect after graduation. Use on-line calculators to determine monthly payments.
Think long term when choosing an alternative loan. You should borrow from the same alternative loan program each year during your college career. This will make repayment easier and more cost effective for you. Private loan consolidation, combining two or more different alternative loans into one new consolidated alternative loan, is possible but the choices are very limited and their terms are not attractive, so you must choose a loan that meets your needs now and for the future.
Thoroughly review and decide how important the various features of a loan are to you before choosing one; these features include fees, grace periods, lengths of repayment terms, how future interest rates are determined, co-signer release availability, borrower benefits and incentives.
We recommend that students apply for an alternative loan with a co-signer. This will reduce any fees, and lower the margin above the index in determining your interest rate.
Choose a loan which has a competitive margin above the index. This margin will determine your future interest rates. An index is a nationally recognized interest rate that is used by the lender to determine your future interest rates. The most popular indices are the Wall Street Journal (WSJ) Prime Rate and the London Inter-Bank Offered Rate (LIBOR). The margin is the amount which is added to the index which determines your interest rate. For example, if the index is a WSJ Prime Rate of 4.00% and your margin is 1% above the margin, then your interest rate is 5.00%.
Historically, the LIBOR rate has been lower than the WSJ Prime Rate, and therefore, the margins above the LIBOR rate are higher than the margins above the Prime rate. For up-to-date rates for the WSJ Prime and LIBOR indices, visit the Bloomberg web site.
Another consideration is the frequency of the interest rate changes. Some loans change every three months (quarterly). Some loans change their interest rates every month. During a time of rising interest rates having your rate change on a monthly basis will cost you more money.
Think about the length of your repayment period and how your monthly payments will be effected. If you plan to borrow more than $20,000 in alternative loans for your undergraduate career, you should consider a loan which offers a 15, 20, or 25 year repayment term. If you choose a loan with a repayment period of 12 or less years your monthly payment will be huge. Don’t forget that you will also have the Federal Direct loan to pay back as well. Play around with the on-line calculators listed in tip #2 above or check out this calculator to see how interest rates and term lengths effect your monthly payments.
You may want a time period between leaving school and when monthly payments begin. Look for an alternative loan which has a grace period when payments are not due. For example, the Federal Direct loans have a six month grace period after leaving school or graduating when monthly principal and interest payments are not due.
If the student cannot make monthly principal and interest payments while enrolled look for an alternative loan which defers these payments. We do, however, recommend that students and/or parents pay the interest that is charged on the alternative loan while the student is enrolled. If the interest is not paid while the student is enrolled the accumulated interest will be capitalized, or added to, the amount borrowed at repayment. By having the interest added onto the principal at repayment interest will be charged on the interest. You want to avoid having this happen to you as this will add to the cost of borrowing an alternative loan.
Be careful of tiered pricing loans. These loans have different fees and margins above the index depending on the credit score of the borrower or co-borrower. The differences can be quite large. Borrowers with excellent credit fare the best with usually no fees and no or low margin over the index. The advantage of the tiered pricing is more loans can be approved using this method. But at what cost to you, the borrower? Paying nine percent of what you borrow in fees and a 5% margin over the index is not a great deal. If you find yourself in a tiered pricing loan ask yourself if you can afford the high margin over a 15 - 25 year period of time. It may be worth thinking twice about borrowing that loan. If you cannot be approved for a tiered pricing loan at the excellent credit level you may be better off not applying for that loan.
Some loans have a co-signer release option. This means that the co-signer can be released from the obligations of the loan after a period of time and the student borrower will remain as the sole signer on the loan. Be aware that to be able to release the co-signer, you must make a certain number of on-time payments before the lender will consider releasing the co-signer. Also, the student borrower needs to prove that he or she is able to make payments on the loan after the co-borrower is released. If this is an important feature for you, inquire about the number of on-time loan payments required to release the co-signer and how is the borrower determined to be able to make payments after the co-signer is released.
Most loans have borrower benefits and payment incentives. Some of these benefits have already been discussed above including the grace periods, deferment of monthly payments, and the co-signer release. Payment incentives include interest rate reductions after certain number of on-time payments, and interest rate reductions for automatic payments from a bank account. A word of caution about incentives linked to making a number of on-time payments: only a small number of borrowers actually benefit from this type of incentive because there may be a late payment made along the way. To safeguard against having late payments, ask what is the window of time when a payment is considered to be on-time. For example, if the payment is due on the 10th of the month, and the window is 10 days, you have until the 20th to make the payment and still be considered on-time. If the window is only 5 days, you need to make payments sooner. To ensure that payments are made on time, ask about paying the monthly bill using automatic payments from your bank account.