In addition to APR, when you shop for a student loan you should consider other important options apply to the product. These include such features as:
- payment options
- repayment term
- lender fees
- variable rate provisions
- borrower benefits
Payment Options: Deferment vs. Immediate Repayment
Many undergraduate and graduate loans are offered with a "full deferment option." If you pick this option, no payments are due until six months or more after you graduate. There is a price for this benefit, which is the addition of interest to your loan balance as interest accrues during enrollment. An alternative option is to make payments immediately. Usually students are not able to do this, but sometimes parents are willing to do so. Finally, some lenders offer the intermediate option of paying interest during school and then paying principal and interest after graduation.
How long do you have to pay back your loan? Most lenders will provide 15, 20 or even 25 years, subject to the requirement that you make a minimum payment of $25 or $50 per month. The longer you have to repay, the lower your monthly payment, but the more interest you pay. Many lenders provide payment calculators on their websites that allow you to compute what your payment would be using different repayment periods. Use a calculator to get a general idea what your payments will be, but remember your actual payment will depend on what "risk based price" you receive upon approval.
Most lenders will charge an "origination fee" or "guarantee fee." Whatever they are called, they are simply additional charges added to your loan amount and subtracted from the money you actually receive. The total cost of your borrowing is the sum of the interest rate the lender applies over the life of the loan plus the fees it applies up front. The only number that can show you the combined effect of all of the lender's charges is the APR. This is why knowing what the APR of a loan is so important in comparing different loans. Obviously, a lender fee of 3% is better than 10%, but only if the lender charging 3% is charging a similar interest rate as the lender who is charging 10%. Comparing APRs is the way to tell who offers the best combination of fees and interest rate.
A prepayment penalty is a fee charged by the lender if you pay off some or all of your loan ahead of time. You should never agree to a prepayment penalty on a variable rate loan. Very few private education lenders assess prepayment penalties on any type of loan. If the lender plans to assess a prepayment penalty, you should try and find another lender.
If you elect to defer payments while you are in school, the lender will add interest to principal from time to time and then charge interest on the interest until it is paid. You should read the disclosures carefully to see if interest is added to principal frequently (e.g., quarterly) or once at graduation. The less frequently interest is capitalized, the less your loan will cost you over the term of the loan.
Private loans generally have interest rates that fluctuate with changes in an "Index." The Index is usually Prime Rate or LIBOR. The Prime Rate is the interest rate lenders offer to their most creditworthy business customers. The LIBOR, or the London Interbank Offered Rate, represents what it costs the lender to borrow money.
The rate will be reset periodically to equal the current Index value plus a fixed margin. In other words, there is a formula used to determine your interest rate and that formula is applied periodically to reset your rate. Once the rate is changed that interest rate will apply to your loan payments going forward-that is, until the next rate adjustment.
There are several important questions to ask about variable rate loans:
- What is the Index and where do I find it? The lender should use a published Index that you can locate and verify.
- Is there a cap on the maximum interest rate? There should be a cap.
- How often does my rate change? Rates can changed annually, biannually (every six months), quarterly (every three months), or monthly. Annual changes level out the peaks and valleys of rate fluctuations; quarterly and monthly changes are common, however.
- What happens to my payment when the rate changes? There are two possibilities: The payment amount may increase (which can produce payment shock) or the number of payments may change (which is generally easier to handle).
"Borrower benefits" is a general term that is used to refer to loan features that a lender adds in order to make its product more attractive. Typical borrower benefits include some or all of the following:
- ACH reduction. If you agree to make your payments by automated debit to a bank account (an ACH transaction), then you may receive a reduction in your interest rate from some lenders. A typical reduction is .25%.
- Cosigner release. Some lenders will accept a request to release a parent cosigner from liability to pay a loan after the borrower has made timely payments for a substantial period of time. If this feature is offered, you should check to see if the lender describes the rules for releasing a cosigner or simply makes the general statement that cosigner release is possible. The more specific the lender is in advance, the better.
- Rate reduction for on-time payments. Many lenders offer a rate reduction after you have made 36 or 48 payments on time (or early). Missing a single payment typically voids this benefit.
There are other borrower benefits in the market, and lenders will continue to invent new ones in order to distinguish their products. You should check one important issue: Is the availability of the benefits guaranteed? Some regulators have taken action against lenders because they offered benefits that "evaporated" when the loans were sold to a new holder who knew nothing about the initial lender's promises. You should check to see if your lender promises that the benefits will be available, regardless of ownership of your loan.