Loan sharks on campus

Unethical behavior by college aid officers doesn't mean you have to pay more for loans than you otherwise would.

By Lynn O'Shaughnessy, Money Magazine contributing writer

(Money Magazine) -- The prospect is anything but appealing: You - and possibly your offspring - will have to borrow gigantic sums to pay those college bills soon coming due.

Worse, you may be getting that money from lenders who haven't been playing fair.

College cost finder
Enter school name
(or part of name)
OR
Choose a state

Your Loan Options
Loan (who owes) Rate Max Loan Amount
Stafford (student) 6.8% fixed Year 1: $3,500; Year 2: $4,500; Years 3 & 4: $5,500
Plus (parents) 8.5% fixed Total cost minus other aid
HELOC (parents) 7.0% 80% of home equity
Private (either) 7.25% to 18.0% variable None

Already the New York State attorney general has uncovered enough about the student-loan industry to make you shudder. Worst among its transgressions: paying kickbacks to colleges to win spots on their "preferred lender" lists, to which students and parents are steered.

Colossal Sallie Mae and two other loan companies have already agreed to multimillion-dollar settlements. And further investigations are in the works.

Might the lenders' scandalous behavior force you to pay more than you would otherwise?

The answer is: not if you're smart about borrowing. The interest rates on PLUS and Stafford loans, which are guaranteed by the government, are capped. Other borrowing options on preferred lists include so-called alternative loans - personal loans from private lenders.

No matter who is on the preferred-lender list, however, federal law gives you the right to get your college loan from any lender. If you decide to use a home-equity line of credit (HELOC), you can get one from any bank.

Despite all that, assembling the money is a complicated business. You'll need to do some careful shopping among the choices.

The parents' burden

If you want to underwrite all college expenses yourself, a HELOC is the cheapest and most convenient choice. HELOC rates were around 7 percent this spring, lower than the PLUS loan rate.

You can repay as you go and deduct all interest paid if the money you actually borrow is less than $100,000. Confine yourself to a line of credit that is no more than 80 percent of your equity so that you have a cushion if home values drop and you have to sell. When shopping, try your own bank first and avoid an interest-only loan.

If you don't have enough equity in your house to pay for college, your next best option is a PLUS loan.

If your child's college is one of the 20 percent that participate in the Federal Direct Student Loan Program - find out from the financial aid office - repayment is made to the Department of Education and no private lender is involved.

Otherwise, private lenders are invited in to sell the loans, and some may undercut the rate cap. Lenders may offer repayment benefits to get your business, a 2 percent rate discount if you make 48 payments in a row.

But if you miss even one payment (and most borrowers do), you won't get the discount. These loans are sometimes resold, so make sure that the lender gives you a written guarantee that repayment benefits travel with the loan.

One disadvantage: You can deduct no more than $2,500 a year of loan interest on your taxes.

The kid's contribution

As with PLUS loans, Staffords come directly from the government or via private lenders. Again, make sure that repayment discounts continue no matter who owns the loan.

You can compare loans using the calculators at FinAid.org, a comprehensive source of aid information.

Of course, the amounts a student can get with a Stafford are pretty stingy. If your scholar needs to borrow more, he or she may have to take out a private loan. But rates range between 7.25 percent and 18 percent, depending on the borrower's credit score, and vary over the life of the loan.

If you must resort to a private loan, look for one indexed to Libor, not the prime rate; and cosign for your child to give him or her the benefit of your higher credit score. Some lenders let you off the cosigning hook after a few years. Top of page

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.