The most important criterion for choosing a student loan is cost. Most borrowers prefer low cost loan. The main factors that affect the cost of a student loan are the interest rate and the length of the repayment period.
Student loan cost
The cost of the loan depends on the interest rate, loan fees, discounts, bonuses, frequency of interest capitalization, loan forgiveness options, and the length of the repayment term.
A higher interest rate means a higher cost. Lower interest rate means lower cost. However, borrowers should prefer fixed rates when interest rates are low, even if the fixed rates are higher than the floating rates, because the floating rate has nowhere to go but higher. A low variable rate can save money, but only if you pay off the debt in full before interest rates go up too much.
There is a trade-off between interest rates and loan fees. A 1% percentage point increase in the interest rate equals a 4% increase in loan fees for 10 years. Therefore, a loan with 4% fee and 9% interest rate costs more than a loan with 5% fee and 8% interest rate.
Loan forgiveness can reduce the cost of a student loan, but most borrowers will not qualify for it. Even when the borrower qualifies for loan forgiveness, some loan forgiveness programs require the borrower to have repaid for 20 or 25 years, which increases the total cost of the loan.
In general, the frequency of interest capitalization has little effect on the cost of a student loan. If interest on a loan is capitalized at 5% per month, it increases the effective interest rate over a 12-month carry period by about 0.1% compared to a loan that draws interest once, at the end of the carry period.
Effect of repayment period on cost
The length of the repayment tenure can have a significant impact on the cost of a student loan.
When comparing the cost of two loans, consider both the monthly loan payments and the total payments over the life of the loan. Differences in repayment terms can affect the total interest paid over the term of the loan, not just the monthly loan repayment.
A shorter repayment period will reduce your total loan payments, but increase your monthly loan payment. Likewise, a longer repayment period will reduce your monthly loan payments, but increase your total loan payments.
For example, a 5-year repayment period has total payments 11% lower than a 10-year repayment period, assuming an interest rate of 5%, but the monthly payments are more than three quarters higher. The 20-year repayment term has monthly payments that are about a third less than the 10-year repayment period, but the total payments are about a quarter larger. The 30-year repayment period cuts monthly payments in half compared to the 10-year repayment period, but increases total payments by more than 50%.
It is not always possible to use the same repayment term to compare loans with different interest rates. In a rising rate environment, fixed rate loans will require a shorter repayment period for lower interest rates.
Use the student loan calculator to compare monthly loan repayments and total payments over the term of the loan.
The annual percentage rate, or APR, combines the effect of an interest rate and fees for a specified repayment period. Although the APR is intended to make it easier to compare loans, the APR only works well when the two loans have the same repayment terms. When the repayment terms differ, a longer repayment term will result in a lower APR, although a loan with a longer repayment term will cost more money.
Shop for the best loans
The lowest advertised interest rate is not necessarily the interest rate you will receive. In fact, more borrowers get the highest advertised interest rate than the lowest. Only borrowers with excellent credit scores are eligible for the lowest interest rates.
Lenders do not publish their interest rate equations, so you will have to apply for several loans to find the one that offers you the best interest rate and fees.
Generally, federal student loans offer the lowest cost and the best set of repayment terms for most borrowers. It does not depend on the borrower’s credit scores or income, unlike private student loans. The Federal Stafford Unsupported Loan and Federal PLUS Loan are not based on demonstrated financial need. Even wealthy students can qualify for these loans. The Federal Stafford loan is less expensive than the Federal PLUS loan.
Apply for Private Student Loans with Creditworthy Cosigner
Apply for private student loans with a creditworthy cosigner.
Base eligibility for private student loans and interest rates on your credit score and your credit score, whichever is higher. (Eligibility also depends on the borrower’s income, debt-to-income ratios, and duration of employment with the borrower’s current employer.)
Therefore, applying for a private student loan with a cosigner will not only increase your chances of getting approved for the loan, but may also lead to a lower interest rate.
More than 90% of private undergraduate student loans require a creditworthy cosigner. These loans are approved on the strength of the cosigner’s credit, not the borrower’s credit, because most students have a poor or non-existent credit history.
However, there is one caveat, and that is the danger to the cosigner. Many parents incorrectly assume that signing a loan is like giving a reference to the borrower. But it is much more than that. A cosigner is a borrower who is equally obligated to repay the debt. Lenders seek repayment from the borrower first as a courtesy. But as soon as the borrower falls behind, the lender will start asking the cosigner to make the loan payments.
Check your credit reports before applying for a private student loan
Errors in your credit reports can affect your credit score, which in turn affects the interest rates you pay.
Check your credit reports for errors before applying for a private student loan.
You can get your credit reports for free at Annualcreditreport.com.
If you notice any errors, you can correct them by objecting to them. The lender has 30 days to correct an error or confirm its accuracy.
Therefore, you should check your credit reports at least 30 days before you plan to apply for a private student loan.