New Advice for Shopping for Student Loans

SHOPPING FOR A student loan used to be as simple as picking a lender off your school's "preferred lender list."

Offered by almost all colleges and universities, preferred lender lists singled out on average four or five lenders that the school's financial-aid office deemed would offer its students the best loan terms and customer service. Not surprisingly, the lenders in those lists typically received up to 90% of the loans taken out by that school's students and their parents, according to New York State's Attorney General Andrew Cuomo.

Earlier this year, Cuomo started an industrywide probe into just how these lists are put together. His findings are changing how students and their parents should shop for student loans. Turns out, lenders have been paying their way onto preferred lender lists for years. The financial-aid offices of many colleges and universities received kick-backs from lenders based on how much students borrowed, in addition to accepting free travel and gifts. Some financial-aid officers were even offered stock in lender companies.

Thanks to the ongoing scandal, colleges are scrambling to clean up their acts — and their lists. Nevertheless, if you're planning to take a loan for the upcoming academic year, reaching for your school's preferred lender list — if still available — isn't enough. You'll have to shop around, study your options and ask a lot of questions. Here's how to find the best loan for your needs.

Decoding the preferred lender lists

Some universities have temporarily suspended preferred lender lists as a result of the investigation, but many continue with the practice. Don't automatically discard the lenders your school recommends, but think of them only as a starting point, says Gary Carpenter, a Certified College Planning Specialist (CCPS) who advises families on the type of student loans they should borrow. Be sure to ask your school what benefits you — the student — will receive if you go with a preferred lender. But then ask what benefit they — the school — will receive as well. (The Student Loan Sunshine Act, if passed into law, will ban any revenue sharing or gifts between lenders and schools. Read more about it in the sidebar.)

Scrutinize the list: In the past, schools often listed several preferred lenders that were owned by the same company, says Mike Kantrowitz, founder of FinAid.org. One such college had a list of five companies, four of which were owned by one of the nation's largest educational lenders, while the fifth sells the loans it originates to that same lender. That's possibly a sign that the school had some sort of deal with that lender, Kantrowitz says: a red flag to look into other lending options, which may turn out to be more attractive.

Be careful if your school tries to discourage you from using an outside lender — you are in no way obligated to stick to the list. Granted, there may be some delays inherent in using a lender that doesn't have a relationship with your school, but that should only add an extra day or two for processing, Kantrowitz says. "If the school starts talking about a delay of weeks and tries to discourage you from going with your lender of choice, then they're not complying with federal regulation," he says. Take such cases to the Federal Student Aid Ombudsman, which helps resolve student loan disputes.

Expanding your options

The thought of researching all student loan options out there can be daunting. Thousands of banks, credit unions and other institutions offer loans, according to Kantrowitz. But it's the largest lenders that do the majority of the business: In 2006, the top 50 lenders represented 83% of loan originations and 96% of consolidations.

FinAid.org lists about 300 lenders along with contact information and links to the company web sites. You don't have to go through all these options, of course. Pick several lenders that you are already familiar with or that have been recommended by somebody you trust, perhaps other parents with children close in age to yours. Better to add just a few lenders to your school's list and study their products well, rather than pick one lender out of 50 without reading the fine print.

Comparing loans

You'd think comparing student loans would be easy. After all, the government sets the interest rates and fees lenders can charge, right? (That's assuming you're looking at federal Stafford or PLUS loans, of course; private loans are an entirely different beast.)

The Student Loan Sunshine Act The House of Representatives passed the Student Loan Sunshine Act in May 2007. If enacted by the U.S. Senate, the new law will: Ban revenue sharing between schools and lenders, bar gifts from lenders, outlaw participation in advisory boards of lenders and staffing of school financial-aid offices by lenders; Require that "preferred lender lists" be created only with the students' best interest in mind; Ensure access to the student's lender of choice, whether or not the lender is on the preferred-lender list; Guarantee oversight of lenders offering private loans; require that schools disclose federal loan options before students take out private loans; Compel lenders and institutions to fully disclose terms, conditions and incentives (e.g. philanthropic contributions) for all loans. Source: Office of the New York State Attorney General.

Think again. To compete with each other, lenders offer an incredibly confusing variety of incentives such as fee waivers, discounts and other promotional perks, Kantrowitz says. One of the most common incentives, for example, is a reduction in the interest rate or the loan principal after you enroll in an automatic debit program or once you make a number of on-time monthly payments, typically 24 or more. Some lenders offer application fee waivers on the front end, others offer rewards on the back end, such as waiving your last six payments or wiping out your balance once you pay it down to $500.

Which perks are best? The ones you get upfront, Kantrowitz says. Those are savings that you get immediately and cannot lose, he explains. If a lender waives the application fee on your Stafford loan, for example, that's an immediate savings of 4% (the maximum fee lenders can charge).

Contrast this with perks that kick in once you enter repayment or after some number of on-time monthly payments: You may never see any of those savings because once you graduate, you will likely consolidate your loans, Carpenter says. That's because consolidation loans have their own incentives, different from those offered on Stafford or PLUS loans.

Logically, if you're shopping for a consolidation loan discounts for on-time payments do matter. But do keep in mind that less than 25% of students make enough on-time payments to qualify for such reductions, says Kantrowitz.

One thing to watch for: Some lenders might make you repay any upfront benefits you have received if you consolidate your loan with a different lender. Be sure to read the fine print.

Online help

Still confused about loan shopping? SimpleTuition.com, a new online service can do the job for you. It can be helpful, but has some drawbacks.

SimpleTuition allows you to compare lender offers by calculating the total cost of the loan and number of payments. It also calculates your actual annual percentage rate, which factors in all borrower benefits, fees, and other loan terms along with the loan's interest rate. You have the option to not include borrower benefits in the calculations: a good idea, since you already know promised discounts for on-time payments don't always kick in.

The caveat: Loan listings aren't comprehensive. Currently, only about 45 lenders are included, although SimpleTuition CEO Kevin Walker says the company adds two to three new lenders every week. Most notably, Sallie Mae — the nation's largest educational lender — doesn't participate in the Stafford loans category yet.

SimpleTuition is free for consumers and gets paid by its partner lenders when you click on the offer or apply for a loan. Keep in mind, the company's partners are listed first in the initial search results: You'll have to sort the results by one of the available factors — total cost of loan, APR, and so on — in order to get true results.