Comparing Credit-Based Loans

Many of you already are knowledgeable about loans and financing.  For those of you with limited expertise, here are some general guidelines for deciphering the terms and conditions of the various credit-based (Federal Direct Graduate PLUS, private) loan programs.  We hope that this will help you begin to educate yourself about the various options available to you.  It is recommended that U.S. citizens and eligible noncitizens apply for federal loans before private/alternative loans because federal loans generally have better terms and conditions.

When trying to figure out how expensive a loan program is, there are two initial criteria to consider:  (1) interest rates, and (2) fees charged for origination/default.  

While some private loan programs offer a fixed interest rate, other private loan programs have interest rates that are variable.  Variable private loan interest rates usually are based on the "Prime" rate, a “Treasury Bill” rate, such as the “91-day T-Bill” or “13-week T-Bill” rate, or the London Interbank Offering Rate (LIBOR). LIBOR is an index similar to the US T-Bill and Commercial Paper.  Interest rates on most private loans usually are based on one of these variable rates plus/minus a set percentage, such as “the 91-day T-Bill + 3.75 percent.” As these rates fluctuate with the market, the interest rates on the loans go up or down. Most lenders adjust interest rates on a quarterly basis. There also may be different interest rates used when you are in school versus when you are in repayment. For loans borrowed July 1, 2013 and after, the credit-based Federal Direct Graduate PLUS loan offers an interest rate that is adjusted each July 1st, and then is fixed for the life of the loan; the interest rate is based on the 10-year T-Bill rate + 4.6 percent.

The current Prime, T-Bill, and LIBOR rates can be found online and, of course, the current interest rates on the loans can be verified with the lenders at any time.  What you have to decide for yourself is which rate will be comparatively lower in the long run.  Since we don’t have the answer on what will happen in the future, you will have to use your best judgment.  Also, remember that the amounts added to any of the base rates for each loan will make it comparatively cheaper or more expensive. Again, for loans borrowed July 1, 2013 and after, the Federal Direct Graduate PLUS loan offers an interest rate that is is adjusted each July 1st, and then is fixed for the life of the loan; the interest rate is based on the 10-year T-Bill rate + 4.6 percent. That fixed rate of the Federal Direct Graduate PLUS loan may be higher or lower than a variable rate depending on fluctuations in the market. 

Guarantee or default fees are the lender’s insurance against your defaulting on the loan, and origination fees are charged for the disbursement of the money. Some fees are charged up front and usually come right out of your checks, so you will actually net less money than you borrowed. Lenders may also add on an additional fee at the time you go into repayment; some lenders assess these fees on the original principal, and others on the original principal plus the accrued interest. So, when considering how much a loan program charges in fees, make sure that you add up both the fees charged initially at disbursement, and any fees charged at the time you go into repayment. Some private loans charge no fees, either at the time of the loan’s origination or at repayment. Currently, the Federal Direct Graduate PLUS loan’s origination fee is based on the principal borrowed and the date the loan was first disbursed. Please refer to the Federal Student Aid website for the applicable fees. 

International students cannot apply to most private educational loan programs without a credit-worthy cosigner who is a U.S. citizen or permanent resident. Even for students who are U.S. citizens or permanent residents, some loan programs are only available to full-time students with a credit-worthy cosigner, while other loan programs may offer a choice, and charge lower fees on cosigned loans. Securing a cosigner could give you more borrowing options or reduce the cost of your loan. However, there are drawbacks for cosigners, which they should consider carefully before agreeing to cosign a loan. For instance, cosigners are responsible for the loan if you default. Also, the loan is reflected on their credit report, and it is counted towards their total indebtedness, which may be a consideration for cosigners who are trying to secure a mortgage or other loans for themselves. The Federal Direct Graduate PLUS loan requires an endorser only when the student is not credit-worthy; the fees remain the same with or without an endorser.

Even if you have a cosigner, most loan programs are still going to look at your own credit history when considering you for a loan. While your cosigner’s credit may be excellent, your own adverse credit may still cause the loan to be denied. In such cases, you will need to have a credit-worthy individual take out a loan on your behalf, and usually begin making payments on the loan immediately. For the Federal Direct Graduate PLUS Loan program, if you don’t meet the credit requirements, you can still obtain the loan with an endorser who does meet the credit requirements. If you are concerned about your own credit, we recommend that you obtain your credit report and review it. Also, it is highly advisable that you apply for a credit-based educational loan as early as possible (in May or early June prior to your enrollment). Because most lenders offer online or telephone applicants a very quick, and often immediate, credit decision, you will be able to determine early if you can have access to the loans you will need for your studies. Of course, the Financial Aid Office will have to certify your eligibility for any loan amount you request, based on the cost of attendance and any other aid you may be receiving.

Capitalization is important because it adds to the total cost of your loan. From the moment your loan is disbursed, interest begins to accrue on the principal amount that has been disbursed. Capitalization occurs when the interest that has accrued so far is added to the principal—from that point on, you’ll be charged interest on both the principal and the capitalized interest. Since you’re paying interest on interest, capitalization can become very expensive, and the more frequently a lender capitalizes the interest, the more that loan will cost you. Some educational lenders capitalize accrued interest only once, when you enter repayment at the end of the grace period. However, other lenders capitalize once a year, or even more frequently, so check to see how often your lender capitalizes interest. Of course, you will avoid capitalization and reduce the cost of financing your loan if you pay the interest before it is capitalized.

Since you will be responsible for paying back the loans that you borrow, you must decide which credit-based loan program(s), if any, you choose to finance your Law School education. Moreover, it is your responsibility to know the terms and conditions of any loans you borrow, and you have the best idea of your future plans and how your loans will fit into them. For example, factors such as whether or not you will make interest payments before capitalization, as well as the amount of time over which you plan to repay the loan, will affect how expensive a loan will be for you. Cosigners are typically required for international students, but other students must decide whether or not having a cosigner is an option for them. On the other hand, if your credit history is not satisfactory, you may need to have someone borrow the loan on your behalf, and sometimes even begin making payments immediately. Finally, please be aware that the College Cost Reduction and Access Act of 2007 contains a section (401) pertaining to Federal Loan Forgiveness for Public Service Employees. The federal loan forgiveness provisions require borrowers to have borrowed Federal Direct Loans or to have consolidated their federal loans through the Federal Direct Consolidation Program. As such, we advise that borrowers carefully consider the available educational loan programs (private versus Federal Direct Graduate PLUS) to ensure that their individual loan borrowing fits into their long-term financial planning. While borrowing through private educational loan programs may provide better loan terms in the short term, it also may limit your options should you decide one day to use the Federal Loan Forgiveness for Public Service Employees program. We encourage loan borrowers to refer to the detail of the Federal Program in determining all relevant issues.

Above all, borrow only what you need. Remember, if you live like a lawyer while you’re a student, you may live like a student while youre a lawyer!