Student loans: Don't get burned

NEW YORK (Money) -- For students who plan to borrow for college, choosing a lender has become a lot more complicated.

In March a scandal erupted when New York State Attorney General Andrew Cuomo launched an investigation into allegations that student loan companies provided kickbacks to university financial aid officers and staffers in order to win more business.

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One key goal was to gain a spot on so-called preferred lender lists - the companies specifically recommended by financial aid officers, which tend to be chosen by most students. Attorneys General in California, Connecticut and other states have launched similar investigations.

Cuomo has already won multi-million-dollar settlements from several loan companies, including Citi and Sallie Mae, the nation's largest student lender. (Sallie Mae (Charts), whose stock price has plunged, recently agreed to a $25 billion buyout by two private equity firms along with two banks.) Several colleges and universities, including the State University of New York, New York University and the University of Pennsylvania, have also agreed to settlements.

Do these disturbing headlines mean that students and parents should avoid borrowing from lenders on the colleges' preferred lists?

Not at all. Most colleges vet lenders closely to make sure that their terms are attractive and that they offer good service, said Kal Chany of Campus Consultants, an independent financial aid consultant in New York City. Still, Chany says, "You should consider the lending list only as a starting point."

Fact is, as the scandals have shown, it's important to shop around, since you may well find a better deal elsewhere. Remember, you are allowed to borrow from any loan company you choose - not just those recommended by the school.

Here are three key points to consider:

Understand why your college is recommending particular lenders. And if it's not clear, ask your financial aid office. "One benefit of the investigation is that college and universities are making an effort toward greater disclosure," says Mark Kantrowitz, publisher of finaid.com, a financial aid information Web site. (Citibank is an exclusive advertiser on the Web site.).

Some colleges may recommend a loan company because it offers great customer service, for example, and not because it offers lowest possible rates.

Look for up-front discounts. At many colleges, lenders have agreed to waive so-called origination fees on Stafford student loans, the main federal loan for students, which run 3 percent of the loan amount.

Scrutinize repayment rules. Many lenders will offer to reduce their rates by 1 percent to 3 percent - the current interest rate on Stafford loans is 6.8 percent. But check to see what strings may be attached.

For example, some lenders may simply guarantee a reduced rate once you start repaying, while many others require that you sign up for an automatic repayment plan and maintain an on-time payment record for anywhere from 12 to 36 months.

For parents taking out PLUS loans, lenders may also reduce rates for on-time payment. Many will also permit interest-only payments if you run into financial trouble.

"Be sure you understand the conditions of these repayment breaks," says Patrick McTee, financial aid director at the University of Denver. "If you have trouble keeping up with your bills, you are better off choosing a lender guarantees to reduce the rate by 1 percent, then one that will give you 2 percent off but only if you never miss a payment."