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By Adam Zoll | 04-12-2012 11:00 AM

A Study Guide for Student Loans

Financial aid expert Mark Kantrowitz discusses the importance of prioritizing federal loans over private lenders and offers guidelines for reducing future student debt.

Adam Zoll: I'm Adam Zoll for Morningstar. While many high school seniors are nervously watching mailboxes for college acceptance letters, many parents are nervously watching their wallets, wondering how they'll pay for the high cost of higher education. For many families, taking out loans is a necessity.

Here to talk about the college loan landscape is Mark Kantrowitz. Mark is the publisher of and Fastweb, two websites dedicated to providing information on college funding options. Mark, thanks for joining us today.

Mark Kantrowitz: Thank you for having me.

Zoll: Mark, for those who may not be familiar with the variety of college loan types that are out there, can you give us a quick overview of some of the different types of loans and for whom those might be best-suited?

Kantrowitz: There's two main types of student loans. There are federal student loans, which are made by the federal government, and then there are private student loans that are also known as alternative student loans, which are made by banks and other financial institutions. The terms of those loans are set by those particular lenders.

The federal government offers several different loan programs, the most popular of which is the Stafford loan program that has a 6.8% interest rate that is fixed. There is a subsidized version for students who have financial need, which currently has a 3.4% interest rate, but new loans starting July 1 will have a 6.8% interest rate.

There are also parent loans, such as a Parent PLUS Loan, which is a federal loan made to parents of undergraduate students, and the Perkins Loan, which is made to students with exceptional financial need.

Zoll: For families who are trying to figure out which of these different kinds of loan types is going to be the best fit for them in their circumstance, where would you recommend starting your research?

Kantrowitz: Well, they should borrow federal loans first, because the federal loans are cheaper and more available, and they have better repayment terms than the private student loans. Even though, the 6.8% interest rate on the Stafford loan may seem high compared with home equity loans of 4.0% or even less, the federal loan has a fixed rate whereas those other loans have variable rates, and right now the interest rates are in an unusually low interest-rate environment. They have nowhere to go but up. The equivalent fixed-rate to a variable-rate loan involves adding 4 to 5 percentage points to that interest rate, plus the home equity loan is secured by the home. If you default on that loan, you can lose the home, whereas if you default on a student loan, they can't repossess your education. So, there's different mix of risks.

Also the federal loans offer a variety of repayment benefits, such as deferments and forbearances, income-based repayment, and public service loan forgiveness, that aren't offered by the private student loans.

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