If you're heading off to school, odds are you're doing it with financial assistance. The federal government offers at least $27,000 in loans to all dependent undergrads pursuing a four-year degree, and at least $45,000 to independent undergrads. The problem is that federal loans have strict limits. Many dependent freshmen, for example, can only borrow $5,500 to cover their first year, a drop in the bucket compared to the $31,701 price tag that accompanies one year at the average four-year public college. Private or "alternative" loans are designed to fill the monetary gaps, but unlike federal loans, which are standardized, interest rates and repayment terms vary significantly between lenders. Here's how to start finding the best deal you can on student loans.
Ask Uncle Sam
An overwhelming number of students take out private loans every year, but many don't have to. According to the Project on Student Debt, one in four private loan borrowers went straight to a private lender without tapping federal loans first. That's a costly mistake, says Mary Johnson, director of financial literacy and student aid policy for Higher One, a company that provides financial services for college campuses.
"Private loans are usually more expensive than federal loans," Johnson says. "Interest rates on private loans are typically variable, meaning they can change with the market, [and] private loans often have additional fees."
Contrary to federal loans, private loans often require borrowers to pass a credit check and many require a co-signer, meaning that a friend or family member will be on the hook if you can't pay your loan, Johnson adds.
Private loans should only be an option after maxing out federal loans, says Nick Valdivia, director of financial aid at California State University, Long Beach. Before taking out a student loan, Valdivia recommends that students have a firm understanding of how much they'll need to borrow and whether there's anything they can do to reduce that amount.
"We encourage [students] to evaluate their expenses," Valdivia says. "Do you really need to spend this much on new clothes that you want to buy throughout the year? Can you live with a roommate to reduce your rent costs. When you're a student and if you have to borrow, if you can cut back costs, it means you can borrow less."
Compare apples to apples
Once you've got a budget and borrowing amount in mind, start shopping around. Private loans vary when it comes to cost and terms, so it pays to compare loans carefully.
"[Students shopping for private loans] need to compare interest rates, repayment terms," says Jodi Okun, founder of the College Financial Aid Advisors consulting firm and a brand ambassador for Discover student loans. "They need to understand whether
the loan [interest] is going to accrue while they go to school. and what's the grace period going to be."
It's also crucial to examine the total lifetime cost of each loan, says Mary Johnson, which can be tricky for loans with variable interest rates that could fluctuate throughout the repayment period.
"The most important things families need to understand before signing on for a private loan with a variable interest rate are how the interest rate is calculated, how often it can change and if there is an interest rate cap," she says.
You'll also need to add in fees. Direct federal loans cap their fees at 1.07 percent for undergraduate students, and 4.29 percent on loans for graduate and professional degree students, but private lenders set their own rates and may charge disbursement, insurance, origination, deferment, repayment or miscellaneous fees, according to the New York Higher Education Services Corporation.
Once you have an idea of the interest, borrowing amount, fees and repayment period, comparing costs is easy. Student loan calculators are the quickest way to do a ballpark comparison -- for instance, FinAid.org offers a fabulously simple one on its website -- but if you need a hand crunching numbers, your school's financial aid office can help.
Evaluate borrower protections
Costs aren't the only factor to consider. Students also need to understand their options if they can't make payments. If a borrower runs into financial problems, the federal government is ready. All federal loans come with certain borrower protections like the ability to postpone payments during periods of hardship, graduated repayment plans to lower monthly payments, and loan forgiveness options that will dismiss your debt after 25 years of consecutive payments (10 years for those working public service professions). Private loans aren't legally required to offer those borrower protections, though many lenders do offer similar programs, and unlike credit card debt, it's extremely difficult to discharge student loans in bankruptcy.
Before borrowing from a private lender, it's vital to understand what happens if you become unemployed, disabled, or can't afford payments, says Nick Valdivia. You'll also want to ask about whether the lender offers release policies for co-signers and what happens if you leave school without graduating.
"Even if [students] don't finish their education, they're still going to be required to pay," says Jodi Okun.
"Average Published Undergraduate Charges by Sector, 2013-14," Trends in Higher Education, College Board,
Deferment and Forbearance for Federal Loans, Federal Student Aid,
"How Much Can I Borrow?" Subsidized and Unsubsidized Loans, Federal Student Aid,
Loan Comparison Calculator, FinAid.org,
Financial Literacy, Higher One,
"Private Loans: Facts and Trends," Project on Student Debt, http://projectonstudentdebt.org/files/pub/private_loan_facts_trends.pdf