Cheaper, Bigger, and Cooler Student Loans

Finally, students and parents can celebrate a little good news: It's getting a little easier and cheaper to borrow for higher education.

The government has responded to the credit crunch by allowing all undergraduates to borrow more money from one of the cheapest federal loan programs, cutting interest rates for needy students, and easing repayment for strapped parents. In addition, while turmoil in the financial markets has driven some banks out of the student loan business, it has attracted upstart companies that are now offering students help making alternative arrangements, such as borrowing from rich relatives. So with a little shopping around, students and parents should be able to find lenders offering at least a small discount on modest-size educational loans.

More money: New federal rules taking effect July l increase the amount that almost every full-time undergraduate will be able to borrow from the federal Stafford program to at least $5,500. The newly expanded federal Stafford loan program will allow upperclassmen to borrow up to $7,500. Students older than 24 or who are independent from their parents can borrow at least $6,000 more than that.

The Stafford loan will cost students no more than 6.8 percent a year in interest and 2 percentage points in fees, for a total annual rate of 7.25 percent. And despite the credit crunch, some lenders are still waiving the fees and offering other small discounts.

Lower-cost loans: In addition, Congress cut the interest rate Stafford loans will charge students who qualify as needy to just 6 percent for the academic year that starts in the fall of 2008. It also has ordered further small cuts to the "subsidized" Staffords (which go only to needy students) in future years. Those reductions will cut the total cost of repaying the loan over 10 years by hundreds of dollars.

Best of all, nearly every student who fills out a Free Application for Federal Student Aid—even those who filled out a FAFSA just a few weeks before school starts and whose parents have high or low incomes—can receive a regular federal Stafford loan.

Once students have graduated, those who go into low-paid public service jobs may eventually get some of their education loans forgiven.

Payment flexibility: Parents are also getting a break under the new rules. Parents who take out a new federal PLUS loan—which can cover their child's full cost of attendance after considering other financial aid—will be able to defer payments until six months after the student leaves school. Also, parents facing financial difficulties because of the housing crunch or medical bills may now be able to get a PLUS loan, despite a poor credit record.

Although they offer some special goodies, such as free insurance, PLUS loans aren't cheap. Lenders can charge a maximum fixed rate of 8.5 percent a year plus 4 percentage points in fees, giving a true maximum annual percentage rate of 9.4 percent. (If a parent gets rejected for a PLUS loan because of credit problems, the student can borrow as much as $7,000 a year more through the Stafford program.) Education loan payments are tax deductible to parents with low and middle incomes.

That's why many parents with good credit, solid income, and home equity find that private loans are often better deals. Parents who can persuade a bank to let them tap their home equity despite today's housing and credit crunches may find banks willing to offer rates that start out as low as 4 percent in the summer of 2008 (though, of course, those rates and payments will very likely rise over time). Homeowners not subject to the alternative minimum tax may be able to deduct the home equity payments from their taxes.

Parents who don't want to touch their home equity may be able to find banks willing to make unsecured loans at similarly attractive rates. Discover Financial Services, for example, says it is offering borrowers with credit ratings in the top 20 percent private education loans at half a percentage point below the prime rate—which means it's charging just 4.5 percent in the summer of 2008. Of course, the payments on those loans will rise when prime rises, as it probably will.

Many parents also prefer private loans because they hope to eventually transfer the debt to the child. But advisers warn that although the student's name may be first on the loan, it can be hard to remove a parent's responsibility for the debt if the student ever defaults.

New and different: Several upstart companies have emerged to help students and parents looking for even cheaper and easier ways to borrow. Students who find a friend or relative willing to lend them college money can pay a small fee to Virgin Money or Greennote to do the paperwork to turn informal lending agreements into business deals that are billed and treated like bank loans. Fynanz is attempting to line up investors willing to lend to students they don't know. It typically demands students be backed by a cosigner.