While savings may decrease the amount of financial aid you qualify for, you and your child will likely be in a much better financial situation on graduation day if you start saving for college now. The more you save now, the less you will need to borrow later. Yet for many students and their families, loans are a reality of higher education. In 2008, two-thirds of graduating seniors had borrowed to pay for at least part of their four-year degree program, accumulating an average debt of $23,2001 (including both federal and private loans). As with the cost of college, this figure is on the rise.
Loans are borrowed funds that must be paid back with interest (or paid back before interest begins to accrue). There are two broad categories of student loans—federal student loans, which are administered by the U.S. Department of Education, and private student loans, which are non-government loans issued by non-governmental lenders, including banks, credit unions and companies such as Sallie Mae.
While federal student loans have strict eligibility requirements and borrowing limits, they traditionally offer several advantages over private loans. For example, federal student loans charge a fixed rate of interest, and payments on principal typically are deferred until six months after the student graduates. Interest on federal student loans begins to accrue when the proceeds of the loan are disbursed to the school—but students who demonstrate financial need may be eligible for a subsidized federal student loan, meaning the government covers (or subsidizes) the interest as it accrues until the deferral period ends and you start repaying the loan. With unsubsidized federal student loans, borrowers can choose to pay the interest as it accrues or allow it to “capitalize.” In other words, the interest rolls into the principal balance, compounding your overall debt. Capitalization can be costly in the long run because, when you begin repaying the loan, you start out with a higher principal balance—and so you wind up paying more in interest over the life of the loan.
In contrast to federal student loans, private student loans usually charge variable interest rates that are often higher than those available for federal loans. In addition, origination and disbursement fees can be high, interest accrues (and is often capitalized) during the student years and repayment options tend to be more limited and less flexible. For example, you might not be able to defer payment on a private loan if you decide to go to graduate school.
|Smart Tip. Regardless of income, parents and students should research—and exhaust—federal student loan options before turning to private loans. Not all federal student loans are based on demonstrated financial need. Ultimately, if you apply for a federal student loan, you will need to complete a FAFSA form.|
Additional Online Resources. The best place to start looking for student loan information is on the U.S. Department of Education's Federal Student Aid and FAFSA websites. Two other helpful sites include The College Board Loan Center and the The Project on Student Debt, which works to increase public understanding of student debt and its implications for families, the economy, and society.
1 Source: Student Debt and the Class of 2008, The Project on Student Debt.