Student loan default rates are on the rise with the Department of Education reporting an increase of 1.8% or 8.8% in FY09 up from 7.0% in FY08. The data represents a total of 320,000 students defaulting on their loans of the 3.6 million borrowers from the period of October 1, 2008 to September 30, 2010. In addition, the 8.8% default rate doesn’t account for those students that have fallen behind on their payments. Given these staggering statistics and the rising cost of tuition, are there any student loans that you would recommend for those planning to attend college?
What’s the best loan you can get?
The government subsidized Stafford loan may be the best loan available with its low 3.4% interest rate and the fact that the interest is paid by the government while you’re at school. To compare, other student loans such as the unsubsidized Stafford loan carry an interest rate of 6.8% and the government doesn’t subsidize the student while they are attending school (you can defer payment though).
The Catch: It can be very difficult to obtain a subsidized Stafford loan because the student must demonstrate financial need. Also, the loan can only get you so far with the maximum loan amount being $23,000 over four years which is only 14% of the total amount needed for most moderate to expensive private four year universities or colleges.
How can I increase my chances of getting a subsidized Stafford loan?
A student likely has a better chance of obtaining the loan if they were to apply to expensive colleges and universities. But, before you go that route, it would be wise to identify what you can afford. Typically, it is recommended to set aside 10% of your gross income for monthly tuition payments and try to keep your debt to income ratio below 1. For instance, if you earn $100,000, you would need to set aside at least $833/month to maintain the 10% of your gross income ratio to pay for a four year college that costs $15,000-$20,000 per year with a 7.9% rate and keep your debt to income ratio below 1. If you applied to a college or university that costs $30,000 to $40,000, you may get that Stafford loan but that will only cover 15-20% of the loan. You would not be able to afford the remaining balance of $137,000 to $97,000 at an 8% rate which is likely the next cheapest loan available.
What do you recommend?
Every situation is different but we highly recommend students and parents try to stay within the $23,000 student loan limit and apply for the subsidized Stafford loan. If $23,000 won’t cut it and you can afford the monthly payments for a larger loan, then parents should consider applying for a PLUS loan. The fixed interest rate for the PLUS loan of 7.9% is higher than the Stafford loan but there is no loan limit. The other alternative is a private loan which can be more expensive than the loans offered by the government and can be risky since they are based on variable interest rates. Although rates are low right now, it is important to be mindful of the fact that you’ll still be paying off the loan five to ten years from now when rates may be much higher. Also, keep in mind that obtaining a private loan is no walk in the park if your credit score is below 650.
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