By Deborah Frankle, Research Analyst

Private or alternative loans comprise a growing share of student loans, despite being more costly than federal student loans. Students and parents are often unaware of the differences between private and federal loans, and many borrowers don’t know which they have until they enter repayment. Unfortunately, despite required informational sessions about federal loans, the majority of college financial aid offices are not doing much to educate students about private loans.

The National Association of Financial Aid Administrators (NASFAA) recently conducted a survey of how financial aid offices discuss alternative loans with their students, results of which can be found in their magazine, Student Aid Transcript. The survey results showed that 63% of financial aid offices do not address alternative loans at all during entrance and exit counseling, the information sessions required when federal loans are taken out and again when the student leaves school. And while 58% of financial aid offices do provide more information about financial planning and debt management than they are required to, only 25% offer in-depth counseling on alternative loans specifically.

Barnard College recently became part of this minority by requiring students or parents who apply for a private loan to talk with the financial aid office before Barnard will certify a students' enrollment (and access to the loan). The goal of these conversations was not to discourage people from taking out private loans, but just to be sure that they understood the differences, cost, and potential consequences involved.
Still, this simple policy change reduced alternative loan volume by 73% in one year. The college found that many who initially wanted an alternative loan were not aware of the associated risks and interest rates, and had not fully considered other viable options. Such a huge drop in private loan volume suggests that the students who were initially drawn to these loans might not have really needed them.

Preventing unnecessary and risky borrowing is good for students, and should be a goal of all financial aid counselors. If the drop in alternative loan volume experienced by Barnard College is anything near the potential alternative loan decreases possible at other colleges, the 73 of college financial aid offices that do not currently guide students through these decisions should consider doing so.

Posted by Edie Irons at 12:15 PM | Permalink

It is easy for consumers to forget just how expensive a few percentage points of interest really is. I made this point on Tuesday in my presentation at the annual conference of the National Association of Student Financial Aid Administrators. Assume you have $10,000 in loans and the interest is deferred for four years of study, and then the loan is paid in equal installments over ten years:

• For a subsidized Stafford loan (on which the government covers interest during deferment), the total interest you would pay during that 14-year period would be $3,810.


• For an "unsubsidized" Stafford loan, the 6.8% interest yields total interest payments of $7,967.


• If you have a private loan with an interest rate of 10%, you would pay $13,085 in interest on top of that $10,000 borrowed.


• At 12%, the cost increases by more than $4,000, to $17,091 of interest.


• At 14%, add another $4,000, to $21,469 of interest.


• At 18%, you pay a whopping $31,921 of interest on top of the initial $10,000 borrowed, more than four times the interest on an "unsubsidized" Stafford loan.

These numbers, and the differences between them, would of course be even larger if you extend repayment beyond the 10 years used in this example. In an uncertain economy, these examples tell you just how valuable that fixed 6.8% maximum interest rate is on federal student loans (and a maximum of 8.5% on parent loans), whether they carry the "subsidized" moniker or not.

If the numbers alone are not enough to convince, there are many other benefits to federal loans. In a NASFAA session I recently attended, Martha Johnston of Citizens Bank provided a helpful list, including:

• Federal loans carry automatic full insurance in cases of death or disability. It's not something parents like to think about, but it happens.


• Home equity loans (which may carry an interest rate that rivals the federal rate) put your home at risk.


• Federal loans have unemployment and economic hardship deferments, as well as up to 60 months of forbearance.


• No prepayment penalties on federal loans, and some ability to extend repayment without a change in the interest rate.


• The interest rate on federal loans doesn't go up when rates in the economy increase. (Though it also doesn't go down if rates were to drop).

Posted by bob shireman at 7:56 AM | Permalink