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Navigating student loan options

NOTE: The following discussion refers to practices in the United States. Please be aware that the details in your location may be quite different.

You have made the big decision to go to graduate school and have sent off your applications. It's tempting to sit back and relax now that you've expended considerable energy putting together all those application materials. You've got more work to do though, to prepare for the day when those letters of acceptance come pouring in. No matter where you decide to attend school, chances are you will need at least some financial aid. Unless you are offered a free ride or are wealthy, you'll need to understand and prepare for the often confusing world of student loans.

Filing your Free Application for Federal Student Aid (FAFSA)

The first step toward obtaining financial aid is to file your FAFSA. Complete it online and submit it to all of the universities you applied to, and once accepted, each will use your FAFSA to determine your eligibility for financial aid. If you do this as soon as possible, you are more likely to receive the best aid packages with the lowest interest loan offers.

The next step you should take is to learn about all of the student loan options you have. You may receive scholarship, fellowship, and grant money (none of which need to be repaid) to help pay for school, but the bulk of your financial aid package will most likely be in the form of loans—money you will eventually pay back. The loan options discussed below are common sources of funding that students use to pay for grad school.

After you file your FAFSA, you'll receive financial aid recommendations from your university's financial aid office. This is the point when you should apply for the suggested loans. Your financial aid office will guide you through this process, but it's good to know the advantages and disadvantages of each loan type before you decide which ones to take out. Once you receive your loan funds, put together a loan management strategy to effectively minimize your debt.

Federal loans

Federal loans come in several forms and are common loan options. The U.S. federal government makes both direct loans—meaning you borrow directly from, and pay back, the government—and Federal Family Education Loans (FFEL), which are disbursed through private lenders such as banks or credit unions. Perkins, Stafford, and PLUS loans are the three most common and available federal loan options.

Federal Perkins loans

Perkins loans are low-interest, federally guaranteed loans distributed by the government to your college or university, which then lends the money to you. This means you pay back your college, not the government. These loans have the lowest interest rate (5 percent), require no collateral (since they are federally insured), and are dispersed sparingly to students with exceptional need. You may receive a maximum of $6,000 per academic year.

Federal Stafford loans

Stafford loans can be subsidized or unsubsidized. These loans are distributed by the government and are repaid to the government directly or through your FFEL lender. Stafford loans have a fixed interest rate of 6.8 percent, meaning your payments will be calculated using this single interest rate for the entire life of the loan.

  • Subsidized Stafford loans are designed for students with great financial difficulty. These loans are subsidized by the federal government, meaning the government pays the interest on the loans during the student's period of enrollment and during the six-month grace period after the student has left school or graduated. In other words, the student doesn't pay any interest on subsidized loans until the repayment period begins after school. You may receive a maximum of $8,500 per academic year in subsidized Stafford loan money.
  • Unsubsidized Stafford loans are available to anyone, but interest accrues during enrollment and the period of deferment.

Note that both Stafford loan types require that the borrowing student be enrolled at least half-time.

Graduate PLUS loans

PLUS loans are low-interest, federal loans made to students to cover the cost of education minus all other aid. They are the last federal loan option a student should explore, meant to bridge the gap between what is offered in scholarships, Stafford and Perkins loans, and the final cost of education. To obtain a Graduate PLUS loan, you must have an acceptable credit history, or a co-signing sponsor with good credit standing. Like Stafford loans, PLUS loans have a fixed interest rate of 7.9 percent for direct loans and 8.5 percent for FFEL loans—higher than Stafford or Perkins interest rates. This higher interest rate makes PLUS loans more expensive than other federal loan types, but cheaper and safer than most private loans.

Private loans

Private loans are available from many lending institutions and are not subject to specific terms or fixed rates like federal loans. The lack of fixed rates means your lending institution can raise your interest rate at any time, costing you more than you might have initially planned for. The low fixed interest rate of federal loans make them the most attractive option, and as a general rule, should be your first loan choice. If your federal student aid offer does not sufficiently cover the cost of your education and living expenses, however, private loans may be a feasible option to cover the difference. Private lenders are competing for your business, so if you decide to take out a private student loan, shop around for the best rates and be wary of variable interest rates which can fluctuate.

Alternatives

If you are attending grad school as a working professional or already possess assets like a home and savings, consider other loan and investment options. You can take out a home equity loan, Education IRA, or 529 plan—an investment plan that can be used to pay for school. Contact your bank and/or financial planner for more detailed information about these alternative options and how they will affect your short- and long-term financial health.

Conclusion and further resources

Grad school is an investment in your future, and what you spend now will most likely pay off later. Be informed about your financial aid options and maintain a long-term strategy for managing your loan debt once you receive your aid package. This will make paying for grad school easier, and your future debt more manageable.