Student Loan Primer

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Understand federal loan differences. Not all colleges generate preferred lists because they participate in a direct federal loan program. About 20% of schools offer their students federal guaranteed loans directly from the U.S. Department of Education through the Federal Direct Student Loan Program. All other students receive federally guaranteed loans through private lenders via the Federal Family Education Loan Program.

Your choice will be easy if the school you attend participates only in the federal direct loan program. At these schools, there is one loan option, which is the same for everybody who borrows this way. (About 30% of direct loan schools also participate in Federal Family Education Loan Program.) In the early days of the direct lending program, many more schools participated, and this competition worried the private lenders. To protect their territory, the outside lenders began offering perks to schools to encourage them to shun the direct program, and it worked. If a school is in the FFEL program, its students can borrow money from countless financial institutions that participate in the program.

Direct loans became available in the 1990s when President Bill Clinton and others concluded that it would save taxpayers a lot of money if the government lent the cash to students without a middle man. It costs the government more when students borrow from outside lenders, but obviously families are worried about their own costs, not the federal government's financial problems.

Many students might prefer sticking with direct federal loans for a compelling reason: Only direct loans provide a financial safety valve that allows borrowers who choose lower-paying careers to make monthly payments based on their income, which can be worth its weight in gold.

What's more, a feature called the income-contingent repayment allows the monthly payments to be calculated based on the size of the loan, as well as the former student's salary and family size. These loans can't drag on for more than 25 years because if they haven't been paid off by then, the debt is canceled. If debt is forgiven, you will owe income taxes on the forgiven amount, but that's obviously a long way off.

As of July 2009, however, borrowers of Stafford loans and Grad PLUS loans, which are strictly for graduate students, can also choose a newer feature called income-based repayments. While it's similar to the income-contingent plan, the new alternative results in lower monthly payments. By choosing income-based repayments, borrowers will limit their repayments to 15% of their yearly discretionary income, which is defined as the amount by which adjusted gross income exceeds 150% of the poverty line. What's more, direct loan borrowers who work full time for at least a decade in public service jobs, will have their loan forgiven after paying it off for 10 years. Other borrowers can qualify for public service loan forgiveness by consolidating their loans into the direct loan program.

While outside lenders can offer income-based repayments, it's unclear how many of them will. If a private lender doesn't, however, a borrower is entitled to obtain a federal direct consolidation loan on the grounds that his or her lender didn't provide the new feature.