Find the Right Student Loan

For college kids and kids entering college, and their parents, navigating the minefield of financial aid is a huge challenge. As the number of outright aid grants falls, student loans play an ever-larger role in putting kids through college.

These loans come in many varieties. Some have very attractive provisions and guarantees, but others can spell trouble for even the most responsible young adults.

The cream of the crop
The federal government provides the best student loans. The most common form of federal loan is the Stafford loan, which supplies money either directly from the federal government or through a private lender like Sallie Mae (NYSE: SLM) or Citigroup (NYSE: C).

The primary benefit of Stafford loans is that their costs and interest rates are regulated by law. For loans for the 2007-08 school year, borrowers pay 2.5% in fees when they borrow the money -- 1.5% as an origination fee and 1% to cover the possibility of default. New loans have a fixed rate of 6.8%.

In addition, some Stafford loans are subsidized by the government, meaning that the government pays the interest while the student is in school. In contrast, on an unsubsidized loan, interest accumulates while the student is enrolled, resulting in higher payments once loan repayment begins.

Another federal loan is called the Perkins loan. Reserved for students who have the greatest need, Perkins loans have no origination fee and a 5% fixed interest rate.

Many parents are also eligible for federal loans for their kids' education. Known as PLUS loans, these feature an 8.5% interest rate on new loans, with loan fees of 4%.

The bottom of the barrel
At the other end of the spectrum are so-called private student loans. Students can get these loans from a variety of private lenders, including banks such as Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), and Wachovia (NYSE: WB), as well as lenders that specialize in the student loan area, such as First Marblehead (NYSE: FMD).

Unlike federal loans, terms on private loans vary widely. Some lenders offer rates below their prime lending rates; others have rates that go into the high teens. Origination fees also come in a wide range, with some lenders charging as much as 12% just to take out a loan.

Out-of-control student debt
With college costs rising at a rate well in excess of inflation, students can assume tens or even hundreds of thousands of dollars in debt when they earn their degrees. And it's difficult to fix the credit problems that can result from taking on too much debt.

In 2005, Congress passed new bankruptcy laws intended to make it harder for debtors to abuse the bankruptcy process to get out of repaying loans. Before 2005, federal loans were generally nondischargeable in bankruptcy, meaning that graduates couldn't get rid of their student loan debt if it came from federal loans.

The law before 2005 didn't extend that protection to private student loans -- the new law eliminated it, making all student loans nondischargeable, except under "undue hardship," a legal standard most borrowers can't reach.

What to do
The consequence of these changes is that students and parents must be just as careful when considering student loans as they would be with credit cards or any other type of debt.

The most important thing is to understand which kind of loan you have -- the same lenders offer several types of loans, so it's easy to get confused. Federal loans tend to offer better terms than private loans.

In addition, thinking about college as an investment may make it easier to weigh the costs involved with education. A college education increases earning power, but a more expensive, big-name school may not enhance a student's prospects enough to justify the pressure of higher debt. A less expensive school may supply the flexibility to pursue as wide a variety of career options and perhaps the same opportunities after graduation.

Whatever you decide, student loans can be a valuable tool to get your degree. If you avoid the pitfalls along the way, a student loan may be the right decision on your path to success.

© 2007 Universal Press Syndicate