How to get a cheap student loan
The most important criterion when choosing a student loan is the cost. Most borrowers prefer a cheaper loan. Major factors influencing the cost of a student loan are the interest rate and the length of the repayment period.
The cost of a student loan
The cost of a loan depends on the interest rate, loan fees, rebates and premiums, the frequency of the interest capitalization, loan waiver options, and the length of the repayment period.
A higher interest rate means higher costs. A lower interest rate means lower costs. However, borrowers should prefer fixed rates when interest rates are low, even when fixed rates are higher than floating rates, as a floating rate can only go up. A lower floating rate can save you money, but only if you pay off the debt in full before interest rates rise too high.
There is a tradeoff between interest rates and loan fees. An increase in the interest rate by 1 percentage point corresponds to an increase in the loan fees by 4 percentage points for a term of 10 years. A loan with 4% fees and 9% interest costs more than a loan with 5% fees and 8% interest.
Loan waiver can lower the cost of a student loan, but most borrowers will not qualify. Even if a borrower does qualify for loan relief, some lending programs require the borrower to have paid back 20 or 25 years, which increases the total cost of the loan.
Overall, the frequency of interest capitalization has little impact on the cost of a student loan. If the interest on a 5% loan is capitalized monthly, this increases the effective interest rate by about 0.1% during a 12 month deferral compared to a loan which capitalizes the interest once at the end of the deferral period.
Effect of the repayment period on costs
The length of the repayment period can have a huge 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 life of the loan, not just the monthly loan payment.
A shorter term reduces the total loan payment, but increases the monthly loan payment. Likewise, a longer term reduces the monthly loan payments, but increases the total loan payments.
For example, if the term is 5 years, the total payments are 11% lower than if the term is 10 years, assuming a 5% interest rate, but the monthly payments are more than three quarters higher. With a repayment period of 20 years, the monthly payments are about a third lower than with a 10-year repayment period, but the total payments are about a quarter higher. A 30-year term halves the monthly installments compared to a 10-year term, but increases the total payments by more than 50%.
It is not always possible to compare loans with different interest rates with the same term. In a rising interest rate environment, fixed rate loans with lower interest rates require a shorter repayment period.
Use a student loan calculator to compare both the monthly loan payment and total payments over the life of the loan.
The annual percentage rate of charge (APR) combines the effects of the interest rate and fees for a given term. Although the APR is intended to make it easier to compare loans, the APR only works well if the two loans have the same repayment terms. With different repayment terms, the longer term leads to a lower APR, although the loan with the longer term costs more money.
Buy the best loans
The lowest rate advertised is not necessarily the rate you will get. In fact, more borrowers are getting the highest advertised interest rate than the lowest. Only borrowers with excellent credit scores will qualify for the lowest interest rates.
Lenders do not publish their interest rate formulas, so you need to apply for multiple loans to find the one that gives you the best interest rate and fees.
In general, for most borrowers, federal student loans offer the lowest cost and the best combination of repayment terms. Unlike private student loans, they are not dependent on the creditworthiness or income of the borrower. The Unsubsidized Federal Stafford Loan and Federal PLUS Loan are not dependent on a 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 a private student loan from a creditworthy co-signer
Apply for private student loans from a creditworthy co-signer.
Student private loans are based on your creditworthiness and the creditworthiness of your co-signer, whichever is greater. (Eligibility also depends on the borrower’s income, debt-to-income ratio, and length of employment with the borrower’s current employer.)
So applying for a private student loan from a co-signer not only increases your chances of getting the loan approved, but it can also result in a lower interest rate.
More than 90% of personal student loans for undergraduate students required a creditworthy co-signer. These loans are approved on the co-signer’s credit, not the borrower, as most college students have thin or nonexistent credit history.
There is one caveat, however, and that is the risk to the co-signer. Many parents mistakenly assume that co-signing a loan is like giving a reference to the borrower. But it is much more than that. A co-signer is a co-borrower who is also required to repay the debt. As a courtesy, lenders require repayment from the borrower first. However, once the borrower defaults on a payment, the lender will require the co-signer to make the loan payments.
Check your credit reports before applying for a personal student loan
Errors in your credit reports can affect your creditworthiness, which in turn affects the interest rates you pay.
Check your credit reports for errors before applying for a personal student loan.
You can access your credit reports for free at annualcreditreport.com.
If you notice mistakes, you can correct them by contesting them. The lender has 30 days to correct a mistake or confirm its accuracy.
Therefore, you should check your credit reports at least 30 days before applying for a personal student loan.