When it comes to your financial future after you graduate college, choosing the correct student loan package can be as important, if not more so, than choosing the right major.

Though a college degree can make you a million dollars over the course of your lifetime, making poor financial decisions about how to pay for college can eat up a large piece of that, in some cases up to a quarter of your estimated income benefit.

The first step to paying off your college loans is to be smart about how you get them. To do that, you need to first understand a few basics about college loans and make a decision about which, if any, are right for you.

The First Rule

The first rule of a college loans is that loans are a last resort. Grants, scholarships, tuition reductions and other forms of financial aid that do not have to be paid back are preferable. Before you apply for student loans, apply for as many scholarships and grants as possible and take stock of your savings for college to see how much you will likely need.

The more money that you take out in student loans, the more that you have to pay back at interest. It is important to make sure that you have enough as to avoid having to borrow money for emergencies at a higher interest rate, but taking out too much and spending money you don’t need it a very bad long-term move as well.
Your college or university financial aid office can help you determine your exact financial needs and will likely even gather your scholarships and loans into a package at your time of admission. That being said, it is important to start thinking about student loans as soon as you realize you need them so you can begin researching which are right for you.

On that note, there are two major types of student loans.

Federal Loans

Once you know how much money you need in loans, you can then get started. However, it is very likely that you’ve already completed the first step, which is filling out your Free Application for Federal Student Aid (FAFSA) and reviewing your Student Aid Report.

In addition to providing you information and being instrumental in getting many need-based scholarships, the FAFSA lets you and your school know which Federal loan programs you can participate in.

There are three major kinds of federal student loan programs, each of which are targeted at different students.

1. Perkins Loan: A Perkins loan is targeted at students with the greatest amount of financial need. Students who are eligible for Perkins loans are already receiving Pell Grants. These loans provide up to $4,000 per year to undergraduates and $6,500 per year to graduates. The interest rate on a Perkins loan is very low, less than 5%, and repayment is made to the school. The loan is subsidized, so no interest accrues while you are in college, and those entering certain professions, such as teaching and law enforcement, can have their loans forgiven.

2. Stafford Loan: The Stafford Loan is the most common type of loan for college students. Stafford Loans are for undergraduate students and provide varying amounts of financial assistance based upon the year one is in college. These loans can be either direct, coming from the Department of Education, or indirect, which are Federal Family Education Loans (FFEL) that come from a 3rd-party lender. All Stafford Loans have their interest capped at 6.8% and may be subsidized or unsubsidized.

3. PLUS Loan: PLUS loans are targeted at either the parents of an undergraduate student or an adult graduate student returning to college. PLUS loans are designed to cover the entire cost of attending the school, less any grants, scholarships and other financial awards. Interest in PLUS Loans are capped at 8.5% and are not subsidized.

To apply for any of the above loans, you should turn to your school’s financial aid office as they can provide you with a list of loans you qualify for and help you build a financial package that covers your expenses.

For many students, this may be all that is necessary but, for others, there may still be gaps in their financial plan for college and they need to go farther.

Private Loans

Private loans, or alternative loans, have become more common in recent years due to the widening gap between tuition fees and what Federal loans and scholarships can provide. However, for most students, private loans provide a worse deal than Federal loans, so they should be used as an absolute last resort.

Private loans come from traditional financial institutions such as banks, credit unions and other private lenders. They typically have a variable interest rate, one that is pegged to some other industry standard, such as LIBOR or PRIME and the total interest is usually more than a Federal loan. However, since this interest is still much lower than credit cards or other form of readily-available loans, they may still be the best option available.

If you are forced to seek out a private loan, it is important to read through the terms and requirements very thoroughly. Be sure that you understand what the interest rate is, when interest begins to accumulate, when repayment is required, what the payments will be and how long will they be required.

Here are a few suggestions for making sure you get the best loan possible:

• If possible, bring someone, such as a parent, who can cosign for you. Even if you can obtain the loan on your own, having a cosigner will provide you with a lower interest rate and, possibly, better payment terms.

• Look for loans fixed to the PRIME interest rate as it is the lower of the two, usually by about 3%.

• Remember that your credit score will determine your interest rates and repayment terms. Check your credit score before you apply and clear up any issues. Even raising your number by 50 points can save you thousands of dollars in interest.

• Getting a private loan can affect your ability to get need-based financial aid, including Federal loans. It is important to check with your school to ensure that getting a private loan will not reduce the amount of other aid available.

• Shop around for your private student loans and find out which bank, credit union or other private lender as the best deal.

In the end, private loans are a necessity in many cases but are the least desirable of all loan options. Higher interest rates combined with a lack of Federal government protections makes them a bad deal for most students compared to the government loans available

Still, if the Federal loans and scholarships don’t make ends meet, a private loan may be necessary.

Consolidation, Deferment and Forbearance

If, when you leave college and repayment of the loans begins, this usually takes place after a grace period set into your loan, and you feel that you can not make the monthly payments on your loan, you have several options to lighten your load:

1. Deferment: Deferment is a temporary arrangement between the lender and the borrower to stop payments on the loan for a period of time. On subsidized loans, deferment also stops the interest from accruing. However, interest will accrue on unsubsidized loans.

2. Forbearance: Forbearance, like deferment, is a temporary stopping of payment requirements, however, interest accrues on all loans, whether they are subsidized or unsubsidized.

3. Consolidation: Consolidation is a new loan where the lender pays off your existing student loans in exchange for one new one. This loan typically has a lower interest rate and lower monthly payments, but a longer repayment period.

As with any loan, it is important to meet the payment terms the best that you can. Those who do not can have interest accruing for many years and can wind up owing many times their original loan amount.

It is best to be smart about how you borrow money on the front end and how you pay it off on the back end. Failure to do so can, and will, cause a great deal of problems.

Bankruptcy

Unlike other kinds of unsecured debt, student loans can not be discharged in bankruptcy save in very extreme circumstances. The law protects student loans from bankruptcy discharges, unlike credit card debt or personal loans.

Though it may be possible to get some private loans discharged in a bankruptcy, all Federally-backed loans are protected so it is important to recognize that any loans you take out with Federal backing will be with you until they are repaid.

Failure to repay your loans can impact your credit score, thus hindering your ability to obtain other forms of credit, make it more difficult to find employment and result in harassment by student loan collectors. You can also find yourself unable to renew a professional license that you hold, may have your wages garnished and can even be sued for the full amount of the loan.

Bottom Line

Student loans are difficult to understand but extremely important. Not only will these loans be what makes going to college possible, but they will affect you for many years after you graduate in the form of repayment obligations.

It is important to understand what you are getting into before you sign the papers and ensure that you both have what you need to go to school and that you are not going to be so burdened with debt after your graduation that you can not claw back out.

In short, student loans are trading on the future. You’re taking money today that you’ll have to repay later. While that is true of all loans, student loans are especially difficult in that you will be repaying them in your first working years, likely your most difficult times.

Be smart about how you borrow money and don’t let yourself get taken in by shady lenders. There are plenty of good, fair and honest sources to borrow money from.