Stafford Student Loans

Parents will probably remember these low-interest loans from their college days as Guaranteed Student Loans. These loans, made directly to students as part of their financial-aid package, have been renamed and split into two mirror-image loan programs.

• If the loan is a Federal Family Education Loan (FFEL), your child borrows from a bank, savings and loan or credit union, but the government acts as guarantor -- meaning that the government winds up reimbursing the bank if your son or daughter defaults.
• If the loan is a Federal Direct Student Loan (FDSL), your child borrows directly from the federal government (through the Department of Education).

You don't get to choose which loan program to borrow from -- if your child's school is one of the 1,300 or so participating in the Federal Direct Student Loan program, you get a government loan; if it's not, you get a government-guaranteed loan from a lender of your choice. You can't borrow through both loan programs in any one semester, but you could wind up with both kinds of loans if your child switches schools, or if the school enters or leaves the direct-loan program during your child's college years.

Loan terms

In any event, the loan terms, interest rates and fees for FFEL and direct loans are identical.

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The interest rate. The interest rate you pay on these variable-rate loans is adjusted every July 1. The rate calculation for loans disbursed after June 30 equals the rate on the 91-day Treasury bill plus 2.3 percentage points, with a cap of 8.25%.

Most Stafford loans disbursed prior to July 1, 1998, are calculated at the rate of the 91-day Treasury bill plus 3.1 percentage points. The rate on all Stafford loans cannot currently exceed 8.25%, regardless of when the loan was made.

Loan fees. In addition to interest, you pay up-front fees that total 4% of the amount of your loan. A 3% origination fee goes to the lender, and a 1% insurance fee goes into the guaranty fund that reimburses lenders for loans in default. Normally these fees are deducted from your loan balance, so from a $2,625 student loan, you really get a check for $2,520, leaving a small difference that has to come from some other resource.

Borrowing limits for dependent students

Most undergraduates are considered dependent students and can take out Stafford loans up to the following maximum limits:

• Freshmen: $2,625
• Sophomores: $3,500
• Juniors and seniors: $5,500

However, you can never borrow more than your school's cost of attendance minus any other financial aid you receive, so you may be eligible for less than the maximum. Over all of his or her undergraduate years, a dependent student can borrow no more than a total of $23,000 (which includes a fifth year or more, if necessary).

Borrowing limits for independent students

The maximum amounts an independent student can borrow in Stafford loans each year (including subsidized and unsubsidized loans, which are explained below) are:

• Freshmen: $6,625
• Sophomores: $7,500
• Juniors and seniors: $10,500

An independent student can borrow up to $46,000 during all his or her undergraduate years. Graduate students can borrow up to $18,500 a year, up to a maximum of $138,500, including their undergraduate Stafford loans.

Subsidized or unsubsidized?

FFEL and Federal Direct student loans may be subsidized, meaning that the federal government pays the interest while the student is in school, during the six months after graduation, and during any period during which the student can defer payments (such as during graduate school). Four years of interest-free borrowing is the best deal going in student loans, so if you qualify for a Stafford loan based on financial need, don't pass it up. The aid packages you receive from the schools will tell you whether you qualify for a subsidized loan.

If not, you'll be offered an unsubsidized Stafford loan, which means that the interest clock begins ticking as soon as your child takes out the loan, even though he or she can defer making payments until after graduation. Unsubsidized loans are available to students regardless of need.

If you have financial need that's less than the annual loan limit, you might be offered a small subsidized loan and an unsubsidized loan. A college junior with just $2,000 of need, for instance, might be offered a $2,000 subsidized Stafford loan as well as a $3,500 unsubsidized Stafford to help cover the family's expected contribution to college costs. (The overall Stafford-loan borrowing limit for college juniors who are dependent students is $5,500.)

Unless you've had a sudden windfall that's going to cover the bills (wouldn't that be nice?), you should always accept the subsidized loan. Before you accept an unsubsidized Stafford, however, compare the costs against other sources of borrowing. If you can borrow at something less than 6%, using a home-equity loan, for instance, you might want to pass up the unsubsidized Stafford. Bear in mind, though, that usually the student takes out and repays a Stafford loan, while a home-equity loan would be your responsibility -- even if you worked out an arrangement for your child to reimburse you later.

Incidentally, if you would prefer that the debt be yours rather than your kid's, you still shouldn't pass up a subsidized Stafford student loan. Let Uncle Sam subsidize the interest for four years; then help your child with the payments if you want to relieve him or her of the debt burden.

When You're Ready to Apply

How to Choose a Stafford-Loan Lender