Federally Guaranteed Student Loans are Good Debt
Author: Sandra Block
Block, Sandra. “Students Often Overlook Federal Loans That Are Great Deals.” ABC News, ABC News Network, https://abcnews.go.com/Business/story?id=3793358&page=1.
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In the Land of Oz, there are good witches and bad witches. Likewise, in the land of borrowing, there's good debt and bad debt. A home mortgage? Good debt, because the interest is tax-deductible, your home will likely rise in value over time, and you'll have a roof over your head. A credit card loan to buy a pair of designer sandals? Bad debt, because credit card interest isn't deductible, your purchase will decline in value and you can't live in your shoes.
Student loans are often categorized as good debt, because a college education is considered a sensible long-term investment. In 2005, the typical full-time worker with a four-year college degree earned 62% more than an employee with only a high school diploma, according to the College Board. And many students can't afford to attend college without borrowing money.
But it's important to understand that not all student loans are alike. Federally guaranteed student loans, known as Stafford loans, have fixed interest rates, now [in 2007] 6.8%, and flexible repayment terms. Any full-time college student, regardless of family income, can take out a Stafford loan.
Private student loans, which are often offered by the same lenders that provide federal loans, are more expensive. Interest rates are variable, so there's no limit on how high they can go. And repayment terms aren't as flexible as they are for federal loans.
Yet despite these drawbacks, private student loan borrowing has soared in the past decade. This year [2007], private loans accounted for 29% of all loans taken out by undergraduates, according to a report released last week by the College Board.
The amount of federal money that students can borrow is limited, and those limits haven't kept up with increases in college costs. As a result, some students who attend high-cost schools rely on private loans to pay for expenses not covered by their federal loans.
But that doesn't entirely explain the growth in private loans. An analysis by the American Council on Education found that one in five undergraduates with private loans didn't first take full advantage of federal loans.
Federalloans
are much cheaper and have many more protections.
So why do borrowers take out higher-cost loans? Marketing probably plays a role. Many lenders advertise private loans on television and over the Internet. The U.S. Public Interest Research Group, a consumer advocacy group, has charged that some of these ads are misleading and entice borrowers to take out unnecessarily high-risk, high-cost loans. Last month [September 2007], New York Attorney General Andrew Cuomo expanded his investigation of the student-loan industry to include lenders and companies that use direct-marketing campaigns to promote their loans. (Major private lenders say they encourage borrowers to take advantage of federal loans before taking out any private loans.)
In addition, recent cuts in government subsidies have made federal loans less profitable for lenders. Consequently, lenders may become even more aggressive in marketing their private loans, says Stephen Burd, senior research fellow for the New America Foundation, a policy institute.
Ads for private loans often point out that borrowers don't have to start repaying the loansuntil six months after graduation. But what they fail to mention is that this feature isn't unique to private loans. Repayments on federal student loans, too, are deferred until six months after graduation.
Many ads for private loans also claim that loan applicants can get their money in less than a week. By contrast, Stafford loan borrowers must fill out a Free Application for Federal Student Aid [FAFSA], which is eight pages long and contains more than 100 questions.
But while the FAFSA takes time, it's time well spent. Congress recently added some important benefits to the federal student loan program. Under a $20 billion financial aid bill enacted last month [September 2007], Stafford loan borrowers will never have to spend more than 15% of their discretionary income on loan payments.
The law also gradually reduces interest rates over the next four years for new federally subsidized Stafford loans, which are available to borrowers who can show financial need. The government pays the interest on subsidized Stafford loans while the borrower is in school.
In addition, borrowers who work in certain public-service jobs for at least 10 years will be eligible to have the balance of their student loans forgiven. But this relief will be available only to borrowers with federal loans.
"There seems to be no reason for students to take out private loans without exhausting their federal eligibility first," Burd notes. "Federal loans are much cheaper and have many more protections."
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