By Edmund Lau, CFA
We’ve had the fortune of helping thousands of graduate students sort out their student loans and create a solid repayment strategy that works with their goals. The key to implementing a loan repayment strategy is to retain as much flexibility as possible. Unfortunately, we’ve worked with students that were misinformed about student loans prior to and during graduate school. Graduate students were told to take out Private student loans and were not informed about Direct Grad Plus Loans. This article discusses why graduate students should 1) generally use Direct Grad Plus Loans before resorting to Private loans and 2) when it does make sense to use Private loans instead.
Why Choose Direct Grad Plus Loans Instead of Private Loans?
To clarify, there is nothing wrong with taking out a Private loan prior to or during school as long as the terms are favorable and you have a well thought out repayment strategy. Generally though, most students will find that the fixed rates on Private loans will be less attractive than the rate on Direct Grad Plus Loans.
It’s possible that a cosigner may be used to qualify for a lower rate, but if you anticipate taking out a significant amount of debt to fund your education, the Federal benefits of Direct Grad Plus Loans can be well worth it. To sum it up, here are 5 key reasons why you should use Direct Grad Plus Loans before taking out Private loans:
- Private lenders may offer “Variable Rate” loans with rates that appear more attractive to the borrower. However, interest rates on these loans change over time. Currently, interest rates are expected to rise for the foreseeable future. Having these Variable Rate loans may cost you significantly more in the long-run. To learn more about Variable Rate loans, click here.
- The interest rate for Direct Grad Plus Loans is now much more reasonable than before. Interest rates on Direct Grad Plus Loans were previously as high as 7.9%, but have fallen to 6.3%. In many cases, the rate on Direct Grad Plus Loans will be more affordable than the rates offered by Private lenders.
- If you can afford to pay back your loans when you graduate, you can always refinance your Federal loans into Private loans once you start working. Combined with a cosigner, this will usually get you better terms and save you more money.
- If you cannot afford to pay back your loans when you graduate, you may qualify for deferment, forbearance, Graduated repayment, Extended repayment, or Income Driven Repayment plans with your Direct Grad Plus Loans. This level of flexibility is not found with Private loans.
- Unlike Direct Unsubsidized Stafford Loans, which have an annual cap of $20,500, Direct Grad Plus Loans have no cap and the borrower can borrow up to the remainder of the annual estimated cost of the program. Therefore, there should usually be no reason why a person would need Private loans to fund their education while in school.
These points are extremely important and the sooner you are aware of them, the better. Unfortunately, if you’ve taken out Private loans in lieu of Direct Grad Plus Loans, there is no way to undo this. On the other hand, you can always refinance your Direct Grad Plus Loans into Private loans at a later date.
When to Choose Private Loans over Direct Grad Plus Loans?
If reducing your overall borrowing cost is your only consideration, there are circumstances when going with Private loans makes sense. In this case, it really depends on how favorable the terms of the Private loans are.
Let’s assume that you are starting a 3-year graduate program and the school estimates your first year's annual cost of attendance to be $70,500. You take out the maximum of $20,500 in Direct Unsubsidized Stafford loans and now have to decide whether to take out the additional $50,000 through a Direct Grad Plus Loan or a Private loan. Let’s compare these two options:
- Direct Grad Plus Loans - One thing to be mindful of is that you will be charged an origination fee of 4.276% with this loan, meaning that you would need to borrow $52,234 to receive $50,000 in loan disbursements. Assuming that you did borrow $52,234 at 6.31%, you stand to accrue $9,888 in interest expense over the next three years. By the time you graduate, you would owe $62,121 and have to pay a total of $83,926 over the next 10 years.
- Private loan - Let's assume that your Private lender does not charge any origination fees. What interest rate would the Private loan need to offer you on a 10 year loan? As shown in the table below, the Private lender would need to offer you an interest rate below 6.94% to make it worthwhile.
By looking at the table above, you might conclude that taking out a Private loan with an interest rate below 6.94% would make the most economic sense, but by choosing the Private loan, you give up the flexible benefits associated with Federal Direct loans. This may not be an issue for those only looking to borrow $25,000-$75,000 in aggregate, but for others who expect to have $100,000-$250,000 in student loan debt, having the Federal benefits will be crucial to designing an effective repayment strategy.
You must take into account these factors when deciding between the two options.
Get Free Help
For those still in school or considering graduate school, become a member of FitBUX to get help on how best to fund your education and form a repayment strategy. For those who graduated, if you need help determining whether refinancing your loans or going on income-driven repayment is right for you, become a member at FitBUX and we’ll help you customize your strategy for free. We have partnered with a number of lenders and walk our clients through the refinancing process from start to finish. Best of all…it’s FREE.