All Loans are NOT Created Equal
Time to talk a little about Alternative Loans.
First let's make sure we are all talking about the same things. When I use the term “Alternative Loans” I mean loans that are taken by parents (and/or students) which are used to finance your Expected Family Contribution. I am purposefully not including student loans (like the Perkins, Stafford or Tech Loan) in this conversation since they have different terms and are usually used to finance a part of the Self-Help.
In this discussion of Alternative Loans, first I think it is important to mention the six “biggies” that MIT uses, and later I will talk about the pros and cons of each.
- MEFA Loan -- Offered by the Massachusetts Educational Financing Authority (MEFA), this credit-based, family loan has several options (fixed vs variable, immediate repayment vs. deferred repayment).
- Federal PLUS Loan -- The Federal Parental Loan for Undergraduate Students (PLUS) is a credit-based, parental loan offered by MIT through the Federal government.
- Citibank Alternative Loan, Sallie Mae Signature Loan, Bank of America Loan, Nellie Mae Excel Loan -- These student-based cosigned loans are offered by outside providers and usually feature variable interest rates and deferred repayment.
- Another main source of financing for families is home equity loans (offered by local banks).
The first thing to remember as you consider what program is right for you is the popular (but very true) axiom “You get what you pay for.” In the realm of alternative loans, this means that the farther afield you go from the basic, “vanilla” loan (parent borrower, immediate repayment), the more expensive the option. And in many cases, what you pay for isn't worth the trouble anyway. Let's examine what I mean.
- Who borrows? The first issue many parents and students concern themselves with is who is the borrower. Some parents feel more secure when their son or daughter borrows the loan, rather than serving as the primary borrower themselves. This is usually false comfort however. There are NO alternative loans which will allow a student to self-finance without a credit-worthy cosigner, so parents will need to serve as a cosigner at a minimum. Additionally under credit law, a cosigner is equally and severally liable for any loan they sign. This means that the only benefit of being a cosigner is that you aren't mailed the bills; otherwise, if the bills aren't paid, the cosigner will be as liable as the primary borrower for lack of payment. In rare cases, you may find a loan program willing to loan to a student on her/his own signature, but students borrowing under these programs will need to have significant credit histories and income sources of their own. You'll pay for these options (no cosigner, student as borrower), even though you may not derive any benefit (or you may not be able to qualify).
- When do you pay? The second issue facing parents and students is the decision about when to begin repayment. Usually borrowers are given one or more of three options: immediate repayment, payment of interest only, or deferred repayment. The choice of a repayment plan is one of personal choice. If payments during the enrollment period are not possible, then certainly deferred payments may be the best choice, but you will pay for this option. Since these loans are (in every case) declining balance loans (meaning that upfront most of your payment is used to pay interest rather than principal in the beginning and as the loan carries on, the payment portions reverse), I do not recommend ever using the interest-only option. When choosing options other than the standard repayment, you will pay for this.
- What interest will you be paying? Another issue of which you need to be aware is that of interest rates. While most of the loan programs available feature variable interest rates (the notable exception in this is the MEFA loan), all variable rates are not the same. Some loans are based on the Prime rate (with a modifier), some on LIBOR, one (the PLUS Loan) on the 91-day treasury bill. These rates can change regularly, and it is important (if choosing a variable rate) to understand several issues: 1) what is the rate based upon, 2) how often has the rate changed in the past, 3) does the interest rate have a cap (a protection as to the highest interest rate which can be charged). If you choose a program which features an interest rate cap, you will probably pay for it.
So how do you pay for it? There are several ways in which loan agencies will pass their costs on to you, and in all cases you want to compare these costs. I would also suggest that it is often the case that when choosing “special” options from above these options are used to pass these costs on to you.
- Origination fees - These fees are either added to or subtracted from the amount of the loan you are borrowing. In some loan programs, the credit-score of your cosigner (or borrower) may result in a different origination fee (if you borrow without a cosigner, there will be a higher origination fee).
- Interest rates - Again, interest rates serve as a way to pass costs on to you as the borrower. In some programs, choosing different repayment terms or cosigner options may lead to a higher interest rate than the base program.
With all of this said, therefore, the two main programs which I recommend are the MEFA Loan (Fixed Interest Rate Immediate Repayment) and the PLUS Loan (although the interest rate for next year will be much higher than the rate this year -- look here for more news in the near future). If students must borrow, then it is a toss-up between the other three programs named.
Important note for those of you choosing to use the PLUS Loan. Keep in mind that MIT is a Direct-lending institution, therefore we do not participate in any FFELP PLUS Loans (where a bank or third-party serves as a lender). So, if you are interested in using the PLUS Loan, make sure you use our application form, not one from a bank or lender.
Questions, comments, clarification needed?