Choosing federal over private loans can help keep student debt in check

SLM Corp., commonly known as Sallie Mae, recently reported a significant drop in its private lending. In its third-quarter report, the nation’s largest student loan lender said it had originated $893 million in private education loans, a decrease from $2.1 billion for the same quarter a year ago.

The reason for this trend is obvious. The recession has broken the trend toward private loans, which generally carry higher interest rates than federally subsidized or unsubsidized loans. Additionally, borrowers don’t get the same protections or perks. For example, the government pays the interest on subsidized Stafford Loans and Perkins Loans while a student is in school.

Subsidized Stafford loans are awarded to students who have demonstrated financial need. Unsubsidized loans are awarded regardless of financial need, and students are responsible for the interest, although they don’t have to make payments while in school.

Clearly of the two types of loans, subsidized is better because with an unsubsidized loan, unpaid interest that accrued during the in-school period and the six-month grace period after leaving school is added to the loan principal.

”Students should always borrow federal first, as federal loans are cheaper,” said Mark Kantrowitz, publisher of FinAid.org and FastWeb.com.

The interest rate on federally subsidized Stafford loans dipped from 6 to 5.6 percent in 2009-10, and is scheduled to decline to 3.4 percent in 2011-12.

Kantrowitz also points out that federal loans have better consumer protections, such as economic hardship deferment and flexible repayment plans.

Interest rates for private student loans currently range from about 9.5 percent to 10 percent, says Tim Ranzetta, president of Student Lending Analytics.

Still, about 15 percent of undergraduate students borrowed from private lending sources in 2007-08.

Last year, annual federal loan limits rose from $23,000 to $31,000 for dependent undergraduates, $46,000 to $57,500 for independent undergrads.

Is shifting borrowing from private student loans to federal loans good for students and their parents? It certainly got a lot of thumbs up. ”Absolutely, it’s great that private loan borrowing is down, but with one caveat,” Ranzetta said. ”Is this going to lead to overborrowing with federal loans?”

No doubt it will.

”We are very concerned some students are borrowing much too much,” said Sandy Baum, senior policy analyst at the College Board..

Michelle Singletary is a columnist for The Washington Post. She can be reached at singletarym@washpost.com.