Choosing a student loan can be confusing, especially for college students who don’t have previous experience with debt, but parents can help.
Key considerations should include the cost of the loan, the flexibility of repayment terms, and the quality of customer service. You can help your student avoid potential traps, such as the tradeoff between a lower monthly loan payment and a higher total payment over the life of the loan.
What Parents Need to Know About Choosing a Student Loan
1. Borrow Only What Your Child (and Family) Need
Student loan debt may be good debt because it is an investment in the student’s future, but too much of a good thing can hurt you. Borrow only what you need, not as much as you can.
Don’t borrow more than you can afford to repay. Compare total student loan debt at graduation with the student’s expected annual income. If you keep student loan debt in sync with income, you should be able to repay your student loans in ten years or less.
If your total student loan debt exceeds annual income, your student will struggle to repay their student loans on the standard repayment plan. They might need an extended repayment plan or an income-driven repayment plan to afford the monthly loan payments. These repayment plans double the repayment term and more than double the total interest paid over the life of the loan.
2. Borrow Federal Loans First
Federal loans are generally cheaper than private student loans.
Federal student loans have several benefits that are not available with private student loans. They offer low fixed interest rates that don’t depend on credit scores, longer deferments and forbearances, the current payment pause and interest waiver, death and disability discharges, income-driven repayment, and student loan forgiveness.
But, federal student loans have annual and aggregate loan limits, so a student may need to borrow parent or private loans after they reach these limits to cover the remaining costs.
3. Carefully Consider Cost
The cost of a student loan depends primarily on the interest rates and fees, but also any discounts. Many student loans offer an interest rate reduction for borrowers who sign up for autopay, which automatically transfers the monthly payments from the borrower’s bank account to the lender. Some lenders may also offer rewards for good grades or upon graduation. Here are a few considerations that will impact the overall cost of your child’s student loans:
- Shop Around for the Best Interest Rates & Fees. Compare private student loans based on the actual interest rate you’ll be charged, as opposed to the best advertised rate. Only those borrowers with the best credit will qualify for the best advertised rate.
- Know the Difference Between Fixed & Variable Interest Rates. Fixed interest rates remain unchanged over the life of the loan. Variable interest rates can change periodically, typically on a monthly, quarterly, or annual basis. Given that interest rates are at or near record lows, variable interest rates are likely to increase. Unless you will be able to pay off a variable-rate loan before the interest rates rise too much, it is better to stick with a fixed interest rate. It’s important to understand the difference between fixed and variable interest rates before choosing a student loan.
- Consider Cosigning Your Child’s Private Student Loans. More than 90% of private student loans for undergraduate school and more than two-thirds of private student loans for graduate school require a creditworthy cosigner. So, if a parent is willing to cosign a loan, they can increase the odds of the loan being approved. Even if the student can qualify for a private student loan on their own, cosigning the loan may yield a lower interest rate.Just remember as a cosigner you are equally responsible for repaying the loan. Some private lenders may offer a cosigner release option after satisfying certain credit and payment criteria but check prior to taking out the loan.
4. Talk About Repayment Plans with Your Child
Some lenders, like College Ave Student Loans, provide borrowers with the flexibility to choose their desired repayment term.
There is a tradeoff between the monthly loan payment, the length of the repayment term, the total payments, and the total interest paid over the life of the loan.
When comparing two loans with different repayment terms, it is important to compare both the monthly payments and the total payments.
A longer repayment term will reduce the monthly loan payment, but increases the total interest paid over the life of the loan. A shorter repayment term saves more interest but increases the monthly loan payment. The more you pay each month, the more you save.
Some lenders require very short repayment terms for their lowest interest rates. This can save you money. But most of the savings come from the shorter repayment term, not the lower interest rate. You can get a shorter repayment term without refinancing by making extra payments on the loan.
5. Determine Your Family’s Eligibility for Student Loans
Before you can get a private student loan, you must qualify for it.
Eligibility for a private student loan depends on credit criteria, which can include credit score minimums, minimum income thresholds, maximum debt-to-income ratios, and the duration of employment with your current employer.
Eligibility may also depend on enrollment status (e.g., full-time enrollment), degree level, year in school, and field of study.
Most private student loans have annual and aggregate loan limits.
At least a month before applying for a private student loan, check your credit history for free at annualcreditreport.com. Correct any errors by disputing them or by contacting the creditor.
You can improve your credit score by making on-time payments for an extended period of time and paying down debt. Stop carrying a balance on your credit cards. Rehabilitating defaulted federal student loans will remove the default from your credit history and can improve credit scores. You can also potentially improve your credit scores using Experian Boost and UltraFICO.
6. Good Customer Service is Key for Helping You and Your Child
The quality of customer service can vary among lenders.
Key differences can include:
- Self-service options on the lender’s website. Can you update your address by logging into the lender’s website, or do you have to wait on hold with the lender’s call center? Can you make extra payments through the lender’s website?
- What are the call center’s hours? Some lender’s toll-free telephone numbers offer evening and weekend hours, some do not.
- How popular is the lender? Does the lender have a lot of complaints? The CFPB publishes an annual report that lists the loan servicers with the greatest number of complaints.
Parents have more experience with debt than their children and can help them make smarter borrowing decisions. They can help them choose the best loans, avoid borrowing more than they can afford to repay and understand the cost and convenience considerations.
