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- is it worth it to forgo federal protections on a Grad Plus loan in favor of a cheaper private loan?
- “If you have a large amount of savings or high certainty of employment – maybe you have a guaranteed job offer that will be waiting for you -- then you might want to choose the private student loan option if you have very high credit,”
Graduate students, the banks want you. More specifically, they want you in their debt.
Over the past several months, private student lenders have released a bevy of seemingly attractive benefits specifically targeting adults going into graduate programs. Discover, for example, came out in June with a 1% cash reward for good grades, an 0.25% interest rate deduction for MBA students who have taken the GMAT within the past five years and, most importantly, loans with fixed interest rates starting at 5.99%, substantially cheaper than the government’s 7.21% rate for Grad Plus loans. Sallie Mae, for its part, announced in May that fixed rates on its private graduate student loans would start at 5.74%. Meanwhile, Wells Fargo has been offering a 6.12% rate to graduate student loans that originate in 2014.
These lenders also been advertising variable rates – which are subject to market conditions and can change monthly, and therefore are riskier – that start as low as 2.25%, a figure that’s only slightly higher than the average rate of inflation since the 2008 financial crisis.
For anyone comparing student loan options purely by interest rates, private loans with no origination fee and a 5.74% interest rate can sound like a steal. The math supports that hunch: a $45,000 loan for two years of grad school at the Grad Plus 7.2% rate would cost you $63,256.53 by the time you’ve made 10-years’ worth of $527.14 monthly payments. Meanwhile, a $45,000 loan at Sallie Mae’s 5.74% would be paid off after 10-years’ worth of $493.74 monthly payments and cost you $59,248.32 at the end of it all, a full $4,000 less than the federal Grad Plus loan.
Yet for all their attractive interest rates, private loans still lack the consumer protections and repayment options that federal loans carry. Those include loan consolidation and income-sensitive repayment plans such as Pay As You Earn, Income-Based Repayment (IBR) and Income-Contingent Repayment (ICR) that cap your monthly payments anywhere from 10% to 20% of your discretionary income and extend the repayment period from the standard 10 years up to as much as 25 years, depending on the option you choose. (For more on alternative repayment options, click through here.) Federal loans are also eligible for loan forgiveness after 10 years of public service; private loans are not.
Graduate students can borrow up to $20,500 per year in a graduate Stafford Loan, which carries a 6.21% interest rate and 1.072% origination fee. If you need to borrow beyond that amount and wish to borrow federally, you’re facing that 7.21% rate on the Grad Plus loan plus a 4.288% origination fee. You can turn the Stafford’s 6.21% rate into a 5.96% rate by signing up for auto-debit when the loan enters repayment, so maxing out the Stafford before turning to other funding sources makes sense. But if you need more than $20,500, you might wonder: is it worth it to forgo federal protections on a Grad Plus loan in favor of a cheaper private loan?
The short answer is: it depends.
The long answer involves a set of important questions including: what’s your credit history like? What type of graduate degree are you pursuing? What’s the loan default rate of graduates of the program you’re in? What are your chances of being employed soon after graduation? And what’s your tolerance for risk?
Determining the quality of your credit profile is the first thing you should do before committing to the idea of taking out a private loan, because unless you have top-notch credit, you won’t get to enjoy the lowest rate advertised.
“We have a range of rates – a five tier system,” Danny Ray, president of Discover Student Loans, explained in a recent conversation. Based on their credit profiles, Ray says, borrowers can be assigned to any one of the five tiers. The lower your tier, the higher your interest rate. “Our top two tiers have better rates than the federal on the fixed size,” he said.
Though Ray said that “a double digit percentage of people will get that best rate,” double-digit could mean 10% of borrowers get the rate, or 99%, or anything in between. But Discover declined to provide a concrete percentage or even a credit score that would guarantee a person Discover’s cheapest loan, which means to find out for sure whether you’d get a rate that’s lower than the government rate, you’d have to apply for a loan.
(It’s worth noting that applying for a loan counts as a hard credit inquiry, which – irony of irony – can lower your credit score by a few points and will remain on your credit report for two years. However, if you’re looking for an idea as to how creditworthy Discover might rate you, consider the following: a FICO score of 750 or higher is what most lenders consider to be very good, yet less than 40% of Americans have a score that high. There’s not much data on average credit scores by graduate school program, but according to CreditKarma, adults between the ages of 25 and 34 have an average score of 628, a number that is generally considered fair or poor by most lenders.)
The next set of considerations is the type of graduate degree you’re pursuing – and the job prospects it will lead to. Just about every expert interviewed noted that students in an MBA program with a high likelihood of (lucrative) employment is the group of students that can most get away with borrowing privately and even seeking out a variable-rate loan.
“If you are a business school student and you are going to work in the corporate world and you’re anticipating making a good salary and plan to repay that debt, or your employer will pay [the debt down], the short term variable rate loan could be more appealing,” says Patrick Kandianis, co-founder and Chief Revenue Officer for student loan resource site SimpleTuition.
“Plus they might get a signing bonus,” adds Charlie Rocha, Sallie Mae’s chief marketing officer. Rocha has noticed that a greater percent of inquiries for Sallie Mae’s graduate loans comes from students in the nation’s top MBA programs, either because of that signing bonus and attractive salary or because as students of finance, they’re more interest-rate-focused. “We do see where graduate students at elite business schools are looking for the best deal. They will do a weighting and will take advantage of what’s there,” he says.
Now, this isn’t to say that if you have good credit and are pursuing an MFA, MD or a degree that won’t land you in a Goldman Sach’s corner office you shouldn’t consider a private loan. You can. But according to Consumer Financial Protection Bureau student loan ombudsman Rohit Chopra, you have to have a financial cushion in case gainful employment isn’t easy to find.
“If you have a large amount of savings or high certainty of employment – maybe you have a guaranteed job offer that will be waiting for you -- then you might want to choose the private student loan option if you have very high credit,” Chopra says. However, he’s quick to add, “For borrowers who are unsure of what the economy may look like or what job they may get, they’ll want to make sure they have a flexible repayment option.” (And for all the ways that private lenders are trying to compete with federal lenders, income-contingent repayment or pay-as-you-earn programs are not yet options with the majority of private lenders. Two exceptions are Sofi, which offers unemployment protection as well as help with the job hunt, and CommonBond, which also offers job-searching help a deferral option with its loans.)
Finally, says student loan expert Heather Jarvis, it’s important to consider your entire financial picture. If you’re returning to school after more than a decade away from the halls of higher ed, that may mean factoring in people and things that weren’t in your life when you were 18 and entering college for the first time.
“If you’re older you may have additional entanglements – a mortgage, car loan, a family,” she says. “You definitely do have to think about what would be the case for your dependents and not just for the right now, but the interest cost and the future.”
Jarvis notes that while it’s unpleasant to think about, if you’re an older student with kids and a house, car and other assets, you have to consider how your dependents would handle your student debt in the event you die or become severely disabled. More often than not in these worst-case scenarios, private lenders prove less flexible than the federal government.
“Federal student loans have death and disability cancellation provisions. And most private loans do not,” Jarvis says, which means that the government will not come after your family or your assets if you pass away or become permanently disabled. While some private lenders do have this provision, it’s by no means a guarantee so it’s important to read the fine print and ask questions if you’re not sure. “I’d love to see borrowers asking, ‘what about your death and disability provisions and can I read them before I decide?’” Jarvis says.
Yet, for all the many cautions you have to take before agreeing to a private student loan, there is, ultimately, no harm in considering them.
“I think it’s good to know your options. Be able to compare rates and look at your options,” says Kandianis. “You should always at least have the ability to understand what your alternatives might be. It doesn’t hurt to look.”
