Generally, Wells Fargo recommends that students exhaust all of their "free money" (such as grants and scholarships) first, then borrow federal student loans, and if they need additional funds, consider private student loans
.
Graduate student Jennifer weighs the pros and cons of that borrowing strategy in her next segment.
Mistake #2: Not Considering a Private Loan over a Federal PLUS Loan for Graduate Students
When taking out my loan for grad school, I decided that I had better do my research this time. As a grad student, I now qualify for federally subsidized loans. Stafford loans only go so far, and to finance the shortfall, my options are either a Federal PLUS Loan for graduate students or a private loan. A Federal PLUS Loan for graduate students has a fixed interest rate, so of course, this is the best option. But is it really?
The terms for the two loans differ: PLUS loans have a ten-year repayment term, which can be extended with broad deferment options (including one that covers insufficient salary), and a fixed government rate of 8.5%. Private loans have a longer repayment term — up to 25 years depending upon the lender — and relatively narrower deferment options. The interest rate on private loans is based on the Prime Rate
(which is the federal funds rate plus 300 basis points, or 3%), plus a margin (one or more percentage points) based on your credit history.
Now, here's the kicker: for a private loan, the Prime Rate, plus a percentage point or two, may yield an interest rate lower than the Federal PLUS Loan if you have a good credit history. However, choosing a private loan is a gamble. The economy is currently in pretty bad shape, and the Fed has been keeping interest rates low, but inflation is also a risk — it may lead to the Fed raising interest rates in the future. The Prime Rate has ranged from 4 to 9.5% since 2000 and currently sits at 5%. Banks calculate the applicable Prime Rate differently. For example, banks can use the monthly average, yearly average, or the rate on the final day of each month. If you're going to go with the private loan, make certain that you know how your lender will calculate the interest rate.
A private loan may be the way to go if your career path is more certain and you have a good idea of what your salary will be upon graduation — i.e., you don't actually need the longer repayment term, and you can repay the loan sooner before economic conditions change too drastically and take advantage of a relatively certain lower rate of interest. But again, this is a gamble. It might be smarter to go with a Federal PLUS loan if you tend to procrastinate or think that you'll need to utilize the relatively broader repayment deferment options.
Ultimately, it comes down to this: You have to do what's best for your own financial situation, and what might work for one student might be completely wrong for another. So do as Jennifer did — if you need to take out a student loan, weigh your options, weigh your individual tolerance for risk, and after educating yourself, borrow accordingly.
We'll have Jennifer's last piece of advice on Thursday.
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