When it comes to picking what kind of student loan you will use, it is all about interest rates.

Because costs are rising for tuition and fees to go to college, it is becoming more and more common for students or their families to take out loans to pay for it. Not all loans are created equal, however, and the single most important factor when choosing what kind of student loans you will use is interest rate.


What is an interest rate?

Companies lend money in hopes they will make more money. They do this by charging you a percentage of the total amount you borrowed. Often, that percentage is added on and accumulates every year and it can result in you paying a lot more money than you thought you signed up for. You continue to accumulate interest on what you owe until the loan is completely paid off.

To make it easier to understand the interest rates on different types of student loans, here it is, broken down by loan type:

1. Subsidized Stafford Loans

Stafford loans are federally-funded student loans. The interest rate on these loans is set by Congress. There are two types of Stafford loans: subsidized and unsubsidized.

Subsidized Stafford loans are the best loans to get as a student. The fixed interest rates for subsidized Stafford loans is currently 3.4%. The interest on these loans is paid by the government while you are in school. Payments can be deferred if you are in school at least half-time.

These loans are need-based, so your credit does not play a factor in receiving a Stafford loan. You have to be a U.S. citizen or eligible non-citizen, have completed high school or the equivalent (like receiving your GED) and are enrolled at least half-time in an accredited program to receive this loan.

2. Unsubsidized Stafford Loans

The interest rate for unsubsidized Stafford loans is fixed at 6.8%. The interest on these loans accrues from the time it is disbursed to the school, but unlike subsidized, you are responsible to pay the interest that accumulates while you are attending school. Payments can be deferred on the interest or principal if you are in school at least half-time until six months after graduation or six months after you go below being in school half time.

These loans are not need-based. You can borrow up to $12,000 per year, depending on the number of years you have been in school and your degree status.

There is a 1% loan fee that is charged for Stafford loans, whether they are subsidized or unsubsidized.

3. Perkins Loans

A Perkins loan is also a federally-funded loan for both undergraduate and graduate students with higher financial need. Those who have an independent status, for instance, those whose parents no longer claim them on their tax forms, have a higher chance of receiving these loans.

The interest rate on Perkins loans is a fixed 5%. Even though these loans are paid with federal government funds, the school is the lender and the money is disbursed through the financial aid office. The school assesses a student’s need and calculates the amount a student may be eligible for a loan for. The money is paid back to the school. There is a longer repayment grace period on these loans, with up to none months after graduation or going below half-time status.

The borrowing limit on a Perkins loan is $4,000 per undergraduate year of study, up to $27,000, and $8,000 per year of graduate study, up to $60,000, including money borrowed as an undergraduate. There are no additional fees when taking out a Perkins loan.

The U.S. Department of Education gives the following examples of typical monthly payments for Perkins loans.

4. Plus Loans

PLUS loans are loans that can be taken out by a student’s parents and are also federally funded. The interest rates on PLUS loans are a fixed 7.9%, which Congress hasn’t changed since 2006, and funds can be borrowed up to the cost of attending, including room and board or other charges, minus any other financial aid the student is receiving.

The borrower does have to go through a credit check. If the parent can’t pass the credit check, a friend or relative with good credit history can endorse the loan, similar to cosigning.

There is a 4% origination fee based on the amount of the loan that is added to the total loan amount, but no collateral is required and the interest paid on this loan may be tax deductible.

5. Private Institution Loans

Private institutions are willing to loan money to students or their family or friends for school, but the interest rate is tied to the credit score of the borrower. If you have bad credit and the lender, such as Chase, Discover or KeyBank, feels you have a poor credit history, you may receive a higher interest rate.

If you have a cosigner with good credit, the interest rate may be significantly lower because the lender’s risk of repayment is smaller.

Even as such, the interest rate is higher on these loans. Private student loans from Discover have fixed rates as low as 6.79%, and variable rates as low as the Prime Index plus 0.00%, which right now is 3.25%. The Prime Index is usually based on Wall Street Journal’s Prime Rate, based on the federal funds rate and the average prime rates for the top banks in America, although some lenders use their own prime index or, like Chase, the LIBOR or London Interbank Offered Rate.

The advertised interest rates note “as low as or plus a margin,” meaning you’ll get a good rate or low added margin if you have a great credit rating. Those who don’t won’t get that low of a rate. Variable rates may be enticing, but they will start lower and may increase over the life of the loan. Be sure to read the fine print on the interest rate offered for private student loans. Many lenders won’t disclose the final costs or interest rates for a loan until the application process is complete so do your homework before applying.

Depending on the lender, there may or may not be origination fees added to the loan amount.

Most private institutions offer repayment options, allowing students or borrowers to defer payments or pay as you attend school. For an example of repayment at different interest rates at Discover, see this handy calculator.

For your financial sanity, you should regard high interest-rate student loans as a last resort. You should do everything in your power to get scholarships and grants, pay out of your own pocket, borrow on the cheap from family or friends, and use up subsidized loans before you even consider using the other high-interest options.

Bottom line: not all loans are the same. They differ in how much they will lend, how they are repaid, and especially in interest rate. All of these factors can impact your future so make sure you choose and use student loans carefully.

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