Student loans 101: how and where to get student loans for college

When you start looking at colleges, the most striking thing isn't the academic programs, the dorms, the athletic programs or even the social life.

It's the cost.

College is expensive, but fortunately there are tools to help you pay those bills. If you handle things right, there is a great payoff for your investment in the long run.

To start with the bad news, the annual cost of a 4-year degree can run from an average of $9,410 for in-state students at public colleges to $32,410 at private colleges — and that's just tuition and fees. It doesn't cover supplies, living expenses, and various other costs associated with attending college.

The good news is that there are various tools to help you meet those costs. The following are the major types of financial tools you can use to help pay for college. You should use these tools in the order shown below, because they are listed from lowest cost to you to highest cost.

1. Scholarships and grants. These are awards based on academic achievement, athletic or other special skills, or financial need. If you can qualify for this kind of money, it is the best form of college funding because it generally does not have to be paid back.
2. Personal savings. To the extent you can save money for college in advance, it is a more cost-effective than borrowing money because you don't have to pay interest. Also, if you save via a 529 plan you can benefit from tax-free investment earnings that enhance your savings.
3. Student loans. Borrowing can fill in the gap when scholarships, grants, and personal savings don't cover the full cost of a degree. However, it is very important to understand what you are getting into with a loan. It is a financial obligation that will affect you for years to come, and the interest charged means you will be expected to pay back more than you borrow.

This article will focus on student loans. Consider it an early part of your college education — student loans 101.

How do you get student loans?

Before getting into some of the different sources of student loans, here are a few key terms it is important to understand:

Amortization schedule. A month-by-month list of all your loan payments broken down into principal and interest components. This shows how quickly your loan balance will be paid down, and how much it will cost to pay off the loan.

Co-signer. When a borrower has not established a good credit history, a lender might require a co-signer before making a loan. A co-signer is typically someone with a good credit history who will be responsible for making loan payments if the borrower fails to do so.

Direct loans. These are student loans made directly by the federal government.

Disbursement. This is the issuance of loan funds to the borrower for payment of educational expenses.

Government-backed loans. These are loans either made directly by the government or insured by the government. Generally discussions of government-backed student loans focus on those offered by the federal government, but some states may have student loan programs as well.

Grace period. This is a limited period of time after leaving school during which you will not be required to make loan payments. Generally, anything that drops you below half-time enrollment will trigger the start of a grace period.

Interest. This is a percentage charged on amounts you borrow, which will be continue to be assessed on amounts you still owe until the loan is paid back in full.

Loan fees. These are typically one-time charges in addition to interest which may occur either when the loan is originated or when funds are disbursed.

Loan principal. This is the amount of the loan you still owe the lender.

Private loans. These are loans made by for-profit companies rather than by government entities.

Subsidized loans. These are loans for which the government covers some of the interest cost to lower the burden on the student.

Unsubsidized loans. These are loans which may be backed by the government, but for which the student is fully responsible for any interest charges from the time the loan is made.

You may find it helpful to refer to the above definitions during the discussion that follows.

Broadly speaking, student loans come from two sources: the government or private lenders. In each case you will need to be enrolled in a degree program at an accredited academic institution to qualify, and you will have to fill out an application providing financial and background information. Other than that, the process for government and private loans is somewhat different.

Getting a federal student loan generally requires little more than filling out an application and enrolling at least half-time in a qualifying academic program. No credit checks or co-signers are necessary.

In contrast, getting a loan from a private lender is more involved. There are many banks, credit unions and other lenders making private student loans, so you will have to do some shopping around. This involves finding out whether you meet their qualification standards, and then comparing to see which lender offers the most favorable terms.

Private lenders generally perform a credit check, and unless you have established a favorable credit history, they are likely to require you to have a co-signer for the loans. For students, parents often act as co-signers, but this depends on you having a parent with a good credit history who is willing to take on responsibility for the loan in case you fail to meet your obligations.

Where do you get student loans?

You can apply for a government-backed student loan on the Free Application for Federal Student Aid (FAFSA) web site. Filling out your FAFSA application not only initiates the process of getting a student loan, but it will also help you identify other forms of financial aid that you might be eligible for from the government.

In many cases you can also apply for a federal student loan through the financial aid department at the school you have chosen. These departments can also help you identify other forms of financial aid for which you might be eligible.

For private student loans, you will have to apply directly to the individual lender. This is likely to involve filling out an application for each lender and in some cases may involve an application fee, so do some shopping around to identify the right lender before you start filling out applications.

There is a sharp difference in loan terms between private and government lenders, and there are also different types of government loans. If you need a student loan, the following is the priority order from most to least cost-effective:

1. Direct subsidized loans. With government loans in general, there is a grace period after you leave school before you have to start making payments. Subsidized government loans have the added advantage of not even charging you interest until after the grace period. You must demonstrate financial need to qualify for a subsidized government loan. Students with exceptional financial need might qualify for a Perkins Loan, which offers a longer grace period (six months rather than nine months).
2. Direct unsubsidized loans. An unsubsidized government loan has a six-month grace period before you have to start repaying the loan, but you will start being charged interest from the moment the funds are disbursed. This means you will be faced with a choice — start making interest payments while you are still in school, or owe more than you originally borrowed after you leave school.
3. Private lender. Since there are limitations on borrowing through government loans, private student loans can help fill in any gaps. However, private loans are likely to be tougher to qualify for, charge more in interest, and have less lenient repayment terms.

How much of a student loan can you handle?

There are options if you bump up against the limits on government loans. Additional amounts may be obtained through a program called Direct PLUS Loans if you are a graduate student or have a parent who is willing to borrow on your behalf. Beyond that, there are also private student loans available.

However, the issue isn't so much whether you can borrow enough to make it through school, but how much debt you can handle once you graduate. At minimum, you want to make sure your monthly payments are not going to be too big to afford. Also, you shouldn't borrow so much that it will be impossible to earn a good return on your educational investment in the long run.

Before you borrow, look at an amortization schedule to see what monthly payments and total cost that loan will represent after you graduate. Add this to any existing debt and project how much more additional debt you will need to complete your education. That will give you a feel for the debt burden you are taking on.

The potential return on your educational investment comes from the fact that people with a bachelor's degree typically earn over $20,000 a year more than those with just a high school diploma. However, earnings vary greatly depending on the type of job, so do some research into the earnings range for your planned occupation. Keep in mind that starting salaries are likely to be towards the lower end of that range.

Comparing your projected monthly payments to your likely earnings should give you a feel for whether you will be able to afford the debt you are taking on. If things don't go as planned, government loans have programs that can make things easier. These include limiting monthly payment amounts to a percentage of your income, allowing you to delay payments during periods of unusual financial distress, and forgiving a portion of your loans if you go into fields such as public service or teaching at low income schools. Private loans are much less likely to offer this kind of leniency.

Are there risks to student loans?

Student loans have many potential benefits, but they also entail some risks. These risks include:

• Inability to complete degree. If you fail to finish college, you won't get the economic benefits of earning a degree but you will still be responsible for the debt you've accrued.
• Poor academic performance. The job market is competitive. Even if you get a degree, poor grades may inhibit your ability to get a good job.
• Weak demand in chosen field. Besides researching salary levels, it is a good idea to research whether the field you are pursuing is in demand. Otherwise, you might have great academic credentials but few employment options.
• Unmarketable degree. Make sure that the degree you are pursuing is appropriate for the field you plan to go into, and that the school you choose is respected in that field.

Taking on student loans has consequences — both good and bad — for years after you leave school. If you think carefully before you sign up for a loan, you will increase the chances that the good will outweigh the bad.