The majority of students headed to college will take out loans to help pay for it. Their eligibility will be part of their financial aid package. Of 2011-12 full-time students, 52% borrowed federal student loans, according to the National Center for Education Statistics.

Need loans vs. outside-of-need loans

Today loans are the largest form of student aid, making up 41% of the total aid awarded to undergraduates each year. Most students can expect to receive a loan as part of a financial aid package. There are two broad categories of loans: loans based on financial need and loans not based on financial need.

Loans based on financial need

The federal government is the principal provider of need-based loan funds. Your child’s award letter will list the type and amount of need-based loans.

Features of need-based loans

Need-based loans usually share three distinct features:

  • Low interest rates Stafford Loans have a fixed interest rate of 6% (unsubsidized Stafford Loans have a fixed interest rate of 6.8%) and PLUS Loans are fixed at 8.5%. The Perkins interest rate is currently 5%. No credit check is required for a federal student loan.
  • Delayed repayment With a need-based federal student loan, no payments on principal are due until after your child graduates or leaves school.
  • In-school interest subsidy This means the government pays the interest that accrues on the loan while your child is in school and during the six-month grace period after graduation, resulting in substantial savings. Without this subsidy, either your child would need to make interest payments while in school, or those payments would be added to the principal of the loan, making it a much more expensive loan.

Three need-based loans

Typical need-based loans are Perkins Loans, subsidized Stafford Loans and subsidized direct loans. For loans based on financial need, the aid office will help guide your child through the process.

  • Perkins Loan If your child has been awarded a Perkins Loan, the financial aid office sends a promissory note that must be signed and returned. Since the college already has been given its Perkins funds, it simply transfers the loan to your child’s student account as a credit against charges.
  • Subsidized Stafford Loan For a subsidized Stafford Loan, the aid office will ask your child to choose a lender. Many lenders offer online loan applications. Once your child completes the loan application (a master promissory note) and the loan is approved, the money is sent by the lender to your child’s school. The loan amount will appear as a credit on your child’s account.
  • Subsidized direct loans Direct loans work the same way as Stafford Loans except that the federal government is the lender.

Non-need-based loans

These outside-of-need loans are used to help families that can’t afford to pay their expected contribution from savings and current income. Some colleges will include one or more of these loans in your child’s award letter. When reviewing your child’s aid, these loans should be removed and put to the side. When you calculate your family’s share of costs, you may find that it is more than you can afford. If so, it’s time to consider these loans.

Features of non-need-based loans

Non-need-based loans:

  • Usually have higher interest rates
  • Have no in-school interest subsidy
  • May also require immediate repayment of principal

Three non-need-based loans

The three main types of non-need-based loans are unsubsidized Stafford or unsubsidized direct loans for students, PLUS Loans for parents and private loans for students.

  • Unsubsidized Stafford or direct loans Your child must file a FAFSA before applying for an unsubsidized Stafford Loan. The Student Aid Report (SAR) will show if your family has need. If so, your child can take out a subsidized loan and save money on interest payments. We recommend checking with the college to learn what application procedures to follow. Your child must complete the same master promissory note whether the Stafford or direct loan is subsidized or not. Once the loan is approved, the funds are sent to your child’s school.
  • PLUS loans This is a parent loan, sponsored by the federal government, that is unrelated to need. Generally, parents can borrow up to the total cost of education, minus any aid received. Many lenders will provide quick pre-approval for a PLUS loan within minutes, either online or over the phone. Once the application is completed and the loan is approved, the money is sent to the student’s school.
  • Private or alternative loans Private education loans are available to students, usually at higher interest rates than the federal loans described above. In almost all cases, a credit check and approval is required. Colleges and universities may provide a list of private loan sources. You can check with banks or other financial institutions with which you have accounts.

While not considered financial aid loans, for many families, these non-need-based loans can play an important role in making college affordable, particularly for families that are unable to pay the family share from current income and savings.